The Role of the Private Equity Asset Class
In the aftermath of the worst period of the pandemic, expansionary monetary and fiscal policies have been a significant tailwind for asset prices on the global stage, particularly as it relates to equity markets. Public equity relative valuations in the U.S., for example, have risen above prior decades, magnifying the wealth effect and in some cases, creating uncertainty about how sustainable current stock valuations are. As monetary policy has pushed interest rates to their lowest level in decades, the typical “60/40” or “40/60” allocation towards stocks and bonds has become more difficult as real bond yields are either negative or close to negative. Consequently, some asset managers have begun to think outside the box to drive meaningful returns for investors. In so doing, private equity has become one of the more prevalent mechanisms for wealth creation in a world of heightened uncertainties, low interest rates and high stock market valuations relative to historical levels. In this article, we look at how private equity funds have been raising significant capital to drive attractive returns and why growth in this asset class could benefit Jamaica.
Capital Raising and deal exits
Private equity funds typically allocate capital raised from investors towards private companies, typically referred to as portfolio companies. Outside of just allocating money towards these portfolio companies, private equity funds provide considerable management expertise and oversight aimed at ensuring the success of the companies they invest in. Therein lies one of the main advantages of private equities relative to public equities, the funds are able to handpick portfolio companies they believe have the potential to grow meaningfully, provide them with capital and help steer them towards success. This type of investing has become a hallmark of the pandemic period as more investors have been providing private equity funds with capital to allocate to portfolio companies. As of September 1, 2021, PitchBook has reported that the total sum raised by Private Equity growth funds has reached$39.5 billion, thereby being on the cusp of surpassing the $41.2 billion raised in 2019, pre-pandemic. This means that many wealthy investors have been redirecting capital towards these funds at a significant rate, and 2021 is on track to being the largest capital raise for private equity growth funds, ever. Private equity “mega-funds” (funds that have raised at least $5 billion) have also seen significant growth in capital raised in 2021. And while capital has been coming in, funds have also been exiting successful deals at a record level in 2021. Specifically, private equity fund exits (typically the sale of an interest in portfolio companies) have reached a record $355.9 billion in just the first half of 2021, compared to $323.3 billion for the entire 2019 calendar year.
Late-Stage Venture Becomes More Attractive
Typically, what we’ve seen over the last two years is that private equity funds are increasingly seeking areas of the private market to capture market share and generate higher returns. Venture Capitalists who specialize in startup companies are seeing significant challenge from private equity funds who traditionally sought to invest in more mature companies. These private equity funds have found somewhat of a “sweet spot”, investing in new ventures but at later stages. What this targeted approach means is that private equity companies somewhat reduce the risk of a collapse from very early-stage investing (portfolio companies that are just starting up), while investing just early enough to not forego significant returns. The logic of this has been enhanced by the stock market itself: the recent stock market growth has aided private equity investors as the appetite for returns in the stock market has increased. This aid comes in the form of realizing returns through Initial Public Offers (IPO’s). As reported by PitchBook, private equity funds shied away from IPOs before 2020 “due to widespread fears that the market cycle was nearing a recession”. With the crash of the market in 2020, however, and subsequent recovery, it was perfect timing to begin listing fresh portfolio companies and realizing returns.
The Role of Private Equity Funds
The recent surge in capital raises and high-value portfolio exits has highlighted the important role of private equity funds and fund managers as a fairly new avenue to generate an above-average return for investors. It has highlighted other benefits too, as these funds have tended to invest in small companies with high growth potential but lack the right expertise and sufficient capital. In effect, they create a conducive environment for smaller companies to thrive and realize their potential, more often at a far more rapid pace than would be possible without their assistance. They create value for themselves, their investors, and the portfolio companies.
Concluding Thoughts – Jamaica
The current international posture towards private equity firms, in large part, serves as a roadmap for Jamaican companies. Essentially, the private market is a fundamental component of the capital markets and private equity funds, particularly those that focus on early-stage investing, support companies at a pivotal stage. Our local market has incentivized small companies to do IPOs but what some early-stage companies require is not just capital as the stock market provides, but also, strong guidance, and a concrete business model before doing IPOs. Therein lies one of the major roles of private equity funds, i.e., they can get these smaller companies “IPO- ready” and thereby improve the quality of firms that are eventually listed on the stock market. This not only benefits private equity funds as we’ve seen in the international markets but eventually, it benefits public markets and minority investors as stronger, more robust companies get listed.
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Written by Awah Muirhead, Senior Investment Strategy Analyst
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