By David G. Barry
For the past
several months, chief investment officers have been readying their boards for a
downturn in private equity. That decline, however, may be more significant than
many CIOs forecast.
According to a report
presented by the StepStone Group to the Equity: Public/Private Committee
of the Board of Investments of the Los Angeles County Employees Retirement
Association (LACERA), the private equity industry during the first quarter produced
a negative 1.3% return. In contrast, the segment generated returns of 5.6%
during the fourth quarter of 2021, 7% during the third quarter and 13.6% during
last year’s second quarter.
There has been considerable interest in the numbers, given that private equity
results are a quarter behind those of other asset classes, like public equities
and bonds. As a result, when public pension funds reported the results for the
quarter ended March 31, they included private equity results that were from the
quarter ended Dec. 31.
The numbers presented by StepStone provide a peek into what public pension
funds and endowments may be displaying this summer when they roll out results
for the quarter ended June 30.
StepStone Group Partner Natalie Walker, who addressed the LACERA
committee, said “Q1 was a very different story” than 2021 for private equity,
owing to an “extremely volatile market” resulting from Russia’s attack of
Ukraine and supply chain disruptions.
The first quarter, though, will likely not be a one-time blip for the private
equity industry, said Walker.
“We do expect further declines in the second and third quarters,” she said.
“But we remain optimistic that the long-term nature of private investments will
continue to serve LACERA well.”
Venture capital had the worst first-quarter results within the private equity
segment, according to StepStone. It declined 4.1% after returning 6.9% in the
fourth quarter, 8.7% in the third and 15.3% in the second quarter.
Buyouts – or the more traditional private equity – showed a 0.7% decline after
generating 5.5% in the fourth quarter, 6.8% in the third and 13.1% in the
second quarter of 2021. Growth equity, meanwhile, declined 3.9% after showing
gains of 3.7%, 6% and 13% over the preceding three quarters. The one part of
private equity which showed a positive return in the first quarter was
described by StepStone as other, which would include secondaries. It generated
a gain of 1.2% but that too is down from the 5.3%, 6.9% and 17.1% it generated
in the last three quarters of 2021.
The buyout sector, she said, was “flat” compared to the VC and growth equity
sectors – sectors which specifically felt the impact of the drop in technology
stocks. That being said, she does not expect a slew of VC and growth
equity-backed companies to close down. Many of these companies, said Walker,
have a “couple of years of cash runway” and have “been quick to act and play
defense.”
On the buyout side, she said the companies appear to be well financed, meaning
it may take a while for distressed buying or market dislocation opportunities
to present themselves into investors.
A key reason for the decline in returns is that initial public offerings and
mergers and acquisitions of private equity-backed companies also fell in the
first quarter.
According to StepStone’s presentation, only eight companies were able to go
public in the first quarter, raising $1 billion. That’s a 96% decrease from the
46 IPOs and $26.8 billion raised in the fourth quarter of 2021. Private-equity-backed
M&A transactions declined from 933 in the fourth quarter of 2021 to 630 in
the first quarter of 2022.
Returns were not the only thing that fell in the first quarter. Deal activity
was down 25% from the first quarter of 2021 and global private equity fundraising
was down 13% from the fourth quarter at $245.7 billion.
Walker also said that funds raised by U.S. managers accounted for 69% of the
total during the quarter, up from the 10-year average of 62.1%. In contrast,
European managers accounted for only 15.8% of the total, down from the 10-year
average of 22.6% – a figure that she attributed to the volatility caused by
Russia’s invasion.
StepStone, she said, does expect the fundraising pace to be down in 2022
compared to 2021. Walker described this as a positive trend as it will lead managers
to be “more judicious” with their investing activity and slow their fundraising
activity. This, in turn, will provide relief to pension funds and others who
have had to deal with firms constantly raising new funds.