Travers Smith's Alternative Insights: Back to work

A regular briefing for the alternative asset management industry.

At the end of last month, we hosted our third annual Alternative Insights Summit in London. Our theme was Politics, Policy, and Private Capital, and we had a packed agenda – more on that in our next edition.

For the third year running, Coller Capital's Co-Head of Investment and Global Head of Origination, Francois Aguerre, delivered our keynote speech. It was indeed full of insights.

At our 2023 Summit, Francois had wondered whether an AI might take his place at the podium this year – fortunately, not yet. Francois did share Chat GPT's effort to capture the state of the private markets in 2024, but its simplistic view, mainly drawn from Bain's Global Private Equity Report, was no match.

Francois began his keynote by explaining that the macroeconomic indicators tell two stories. There are a number of positives: for example, major stock indices have recovered from a sluggish period, and inflation has come down. But there are still some drags on the market: interest rates remain very high, and a large proportion of LPs are overallocated to private equity.

Given this economic context, it is perhaps unsurprising that reported since-inception returns have fallen a little, albeit from a high base. According to Coller Capital's Summer 2024 Barometer, 62% of LPs report annual net returns of between 11% and 15% since their private equity portfolio began, with just under a third claiming to have beaten 16%. These are good outcomes but, in 2022 and 2023, they were even better: around 40% of surveyed LPs were reporting returns above 16% p.a., although that figure was markedly higher than in the two previous years.

Despite this slight fall in reported returns, LPs continue to have a positive attitude to the private markets. Specifically, 85% of those surveyed intend to increase or maintain their current allocation to private equity. Private credit continues to top the list of popular strategies, with 45% of LPs planning to increase allocations to that strategy, and secondaries are not far behind.

But there are challenges for LPs who want to invest. Francois highlighted the dramatic fall in distributions recently – and explained that the current distribution profile is, in fact, similar to the years immediately following the global financial crisis. This is, in part, because the number of aging unexited companies in buyout portfolios is at a record high, and the median holding period for buyout-backed exits hit 6.1 years in 2023, also a record.

Francois also highlighted that 'Zombie funds' – where the GP is managing out existing portfolios, but has been unable to raise new funds – already feature in nearly half of surveyed LP portfolios.

        
    
" … at the portfolio company level, there is a positive story to tell.  Growth for private equity-backed assets is the strongest it has been in years. Portfolio assets are doing really well. "

As these data points suggest, the market has been characterised by liquidity challenges, with LPs experiencing negative cash flows. Liquidity solutions, including NAV financing and secondary buyouts, are increasingly embraced by LPs to help bridge this market dislocation – although with some reservations. While continuation funds are expected to be the most utilised means of generating liquidity in the coming 12-18 months, more than half of surveyed LPs have concerns about NAV financing – concerns which we discussed in an earlier panel at our Summit.

Although there has been a slowdown in fundraising over recent years, three fund strategies have bucked the trend: buyouts, secondaries, and distressed. However, it has been especially hard for small and mid-size sponsors: the largest funds are raising the bulk of capital. There has been a wave of consolidation among GPs and Francois' view, shared by LPs, is that more consolidation is to come.

The fundraising difficulties for mid-market sponsors are not surprising. Francois catalogued the challenges facing GPs: holding periods are at an all-time high; interest coverage ratios declined in 2023, against the backdrop of high borrowing costs and inflationary pressures; there is a $300 billion maturity wall approaching in 2024-2025. Dry powder is at record highs, adding further pressures on managers.

But, at the portfolio company level, there is a positive story to tell. Growth for private equity-backed assets is the strongest it has been in years. Portfolio assets are doing really well. It is cheaper to buy add-ons, and EBITDA margins are at their highest level in seven years. Exit multiples came under pressure in 2023, but are showing signs of stabilisation.

These market fundamentals led Francois to predict that, after the summer, there will be an inflection point: GPs will want to deploy the dry powder and return to dealmaking. The industry will get "back to work" – a message that hit the right note with our delegates.