Buyout fund returns under pressure despite better asset classes

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Buyout funds continued to outperform the public market over most periods, according to Bain & Company, although there is increasing convergence of returns in the United States.

According to the annual report of the consulting firm Global Private Equity Report, private equity weathered the “perfect storm” of 2020 without hurting returns. Based on 10-year annualized internal rates of return, the funds appear to have avoided the damage they suffered during the global financial crisis.

This was due to two main reasons. First, many fund managers were already bracing for the end of the decade-long recovery cycle by the time Covid-19 hit.

Second, the unprecedented amount of government stimulus paid to markets during the period helped protect the economy and businesses from the worst of the impact of the pandemic.

“While many sectors have suffered real damage, many others have remained intact thanks to central banks, which has helped investors maintain or even improve their performance in all areas,” Bain said.

However, the performance of US-based funds has converged with public averages over the past decade, largely due to the boom in the public market during the period. Bain suggests, based on historical data, that the performance of public stocks will eventually revert to average.

Bain’s analysis shows that realized returns of 2.3 times compare favorably to the five-year average of 2.19 times.

Performance across different sectors has become increasingly varied, with the median multiple of capital invested between 2009 and 2020 for technology, for example, increasing from 27% to 2.9 times from 2.3 times over the decade. former.

Meanwhile, the average multiple of capital invested in the consumer sector fell 28% from 2.5 times to 1.8 times over the same period, Bain’s study showed.

However, just being in the right sectors does not guarantee outperformance. With asset prices soaring, deal multiples have reached record levels and will put increasing pressure on funds to continue to deliver the returns expected of them.

Bain’s analysis of hundreds of funds he co-invests in has shown that multiple expansion and income growth are the primary drivers of private equity returns. It is with the authors of the report who stress the need to improve this blend in order to replicate the yields they have achieved over the past decade.

“The simple math says that GPs who buy companies at these prices will have to generate more value if they are to meet performance expectations, and they will have to do so in a very volatile and uncertain business environment,” the report notes.

“Many industries have fundamentally changed as a result of Covid-19 in ways that can alter profit pools. Customer expectations may have changed; disruptive innovations may have been pushed forward. Companies that can spot the change first and integrate this information into the PE value chain will have a distinct advantage in the post-Covid future. ‘

PE in diversified portfolios

A recent study examining the role of private market funds in diversified portfolios also found that investing in private funds almost always increases average portfolio returns, while reliably increasing Sharpe ratios for portfolios with redemptions and portfolios. real estate funds.

Historically, allocation to buyout funds and real estate funds have both led to better returns and lower risk, found Gregory Brown, Wendy Hu and Bert-Klemens Kuhn in an article published earlier this year.

The researchers used a sample of 3,380 US buyout, venture capital and real estate funds to simulate portfolios from 1987 to 2018 that substitute a portion of the public equity allocation with private funds. They obtained data at the level of Burgiss funds.

“We expected there to be benefits just because we knew the average returns had been better. I was surprised the results were so strong and consistent and you almost always benefited from them, ”said Brown. Citywire.

The researchers also explained the higher costs of investing in private assets, as well as the fees.

They noted: “Institutional investors have diversified their portfolios by allocating them to private market funds for several decades. In addition, the growing interest of policymakers and regulators in broadening the range of investors with access to private markets may soon translate into a boom in investment in private market funds by retail investors.

“While there is anecdotal evidence that these funds exhibit favorable characteristics for investors, such as higher yields and low correlation with public markets, we are the first to provide a comprehensive analysis of the ex post performance of these funds. diversified portfolios.

“Our results support the widely held view that most private market funds have historically generated diversification benefits and improved risk-adjusted returns.”




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