Is European Private Equity at turning point, UBS asks

Investing.com – European private equity is at a potentially critical juncture, according to UBS, and the Swiss bank sets out key questions which could determine its future. 

How quickly will deal volumes recover now that interest rates are falling?

Private equity deal activity has begun to improve, but is still at only half the historical average rate. Falling interest rates (lower financing costs) and an economic ‘soft landing’ should support recovery in activity levels, UBS said.

“We expect deal activity to recover from 2022 / 2023 / 1H24 lows, but estimate that Global PE deal values need to double from 1H24 run rate in order to return to

more ‘normal’ levels. This could be challenging. It could require the PE industry to be more inventive and flexible in the ways it finds to divest assets,” analysts at UBS said, in a note dated Oct. 4. 

“Trade sales, Secondaries, IPOs could need to be a larger share of exit volumes going forwards, alongside the traditional focus on sales to other financial sponsors. Some acceptance of lower exit valuations might also be a consequence.”

Can Private Equity return be sustained at high teens double digit internal rate of return (IRR)?

Higher costs of funding, together with any valuation concessions to stimulate deal activity, could reduce overall returns, UBS said.

The industry has no benchmark for the achievable returns in a ‘normal’ interest rate environment, and “we expect the ‘best’ private equity players will be those that can maintain the highest returns through operational improvement of the businesses they acquire, and identification and execution of bespoke differentiated deals.” 

Can Private Equity fund raising return to structural growth, with 20-40%”re-up” rates?  

This is entirely possible, the Swiss bank added, although it noted two possible challenges to a rapid return to fundraising growth: if we see lower absolute IRRs this could reduce investor appetite to increase allocations to the sector; and with PE capital call rates >2x distribution rates, it could take time for the over allocation to PE during the recent cashflow hiatus to reverse, making it more difficult for LPs to increase allocations in the near-term. 

“We estimate that PE distribution rates may need to stay at double the current rate for at least a year for most PE cashflow pacing models to return to neutral positions,” UBS added. 

Private wealth is an attractive incremental fundraising opportunity, and can it support continued strong growth in assets under management?  

Given the scale of the Total Addressable Market it seems clear that Private Wealth represents a significant new fund raising opportunity for the industry.

However, the current investor debates we are having center on whether it is one that is at least partly required to offset near-term headwinds to institutional LP allocations, fund upsizing and possible fee margin pressure, or whether it is truly an incremental growth driver for the industry.