Private equity remains the largest asset class within alternatives, with $5.9 trillion in assets under management (AUM) as of Q3 2023.1 Forecasts suggest it will continue growing at a robust annual rate of 7.1%, potentially reaching $8.5 trillion by 2028.2 So what is driving this continued growth?
First, consider the vast opportunity set for investors. There are approximately 11,000 private equity-backed companies compared to just 4,600 public companies listed in the U.S. – a ratio of 2.4x that has surged since 2008 (see Exhibit 1).3 And private companies make up 64% of all firms with revenues between $100-$500 million, and over 84% of those with revenues exceeding $100 million.4
This disparity is partly due to a decline in public offerings relative to the late 1990s. Since 2000, the average number of IPOs has been 127 per year, a stark drop from the 307 per year between 1980 and 1999 (see Exhibit 2).5 This year in particular has been another slow year of IPO activity, with the number of public listings just slightly higher than last year, which was amongst the lowest on record.
As companies remain private longer, the median age of IPOs has increased from 8 years during the 1980-1999 period to 11 years since then (see Exhibit 3).6 What does this mean? Well, companies that do eventually go public are likely more mature and their revenue or earnings growth rate is slower compared to when they were still private.
Indeed, the median market value of companies at IPO has risen sharply over the past two decades. This in turn means that investors are likely to achieve higher returns if they invest before the IPO rather than after. One study shows that the annualized returns six months after the IPO were just 2% if the investor allocated funds to the company at the IPO open trade price. In contrast, returns were 40% if purchased at the IPO offer price and even higher, at 55% annualized, if invested as a Series C or D investor (see Exhibit 4).7
So, the first driver of private equity and venture capital growth is the vast opportunity set. The second is the superior value creation in private markets, which has enabled private equity managers to consistently outperform their public market counterparts over the past 20-years.8
However, some question whether this value creation will continue in PE even despite higher rates. We believe it can, and here’s why. If you take a look at the breakdown of GP value creation, there are multiple ways in which PE managers create value. These include buying at a low multiple and selling at a higher one, applying cheap financial leverage and other financial engineering, and implementing operational improvements (see Exhibit 6).9
It is fair to say that buying low and selling high may not be as lucrative today given today’s higher multiples and no more cheap money fueling valuations. And of course, applying cheap leverage is also no longer an option given 5% interest rates – at least not right now.10 But the focus on operational improvement using the expert knowledge and know-how to grow revenues and earnings above public companies – that should continue to be the value generator for most experienced and skilled fund managers.
Indeed, PE-backed companies have historically delivered higher EBITDA growth rates and higher EBITDA margins compared to their Russell 2500 counterparts, and that typically accounts for a large portion of aggregate value creation (see Exhibit 6).11
All in, we do find compelling reasons to believe that growth and performance in private equity will continue. And if history is any guide, skilled private equity managers have consistently outperformed across various interest rate environments. For investors, the focus should be on identifying managers with the right blend of skill, experience, and a proven track record.
1. Preqin Pro, iCapital Investment Strategy, with data based on availability as of Jul. 22, 2024. Note: Historical AUM data is thru Sept. 2023.
2. Preqin Pro, iCapital Investment Strategy, with data based on availability as of Jul. 22, 2024. Note: Annual growth rate based on historical AUM data as of Sept. 2023 and forecasted AUM data as of Oct. 2023 and thru Dec 2028.
3. PitchBook | LCD, World Federation of Exchanges database, iCapital Investment Strategy, with data based on availability as of Jul. 22, 2024. Note: Data as of June 30, 2023.
4. Hamilton Lane, Capital IQ, as of Feb. 2023.
5. Jay R. Ritter Cordell Eminent Scholar, Eugene F. Brigham Department of Finance, Insurance, and Real Estate Warrington College of Business, University of Florida, iCapital Investment Strategy with data based on availability as of Jul. 22, 2024. Note: Data as of April 6, 2024, and is thru year-end 2023.
6. Ibid.
7. Manhattan Venture Research, FactSet, PitchBook, CB Insights, iCapital Investment Strategy, with data based on availability as of Jul. 11, 2024. Note: Analysis as of May 9, 2022, and includes all technology media and telecommunication (TMT) IPOs over a 10-year period - from 2011 to December 2021 where data was sufficiently available. Only companies with US IPOs listed in FactSet and CB Insights during this period are included and excluded IPOs on non-US exchanges. Analysis does not include companies that went public through SPAC mergers. The sample size is 147 companies with Series A data for all 147 companies, Series B data for 145 companies, Series C data for 133 companies, and Series D data for 119 companies.
8. Bloomberg, Preqin, iCapital Investment Strategy, with data based on availability as of Jul. 22, 2024.
9. Boston Consulting Group, iCapital Investment Strategy, with data based on availability as of Jul. 11, 2024. Note: Data as Feb. 19, 2016.
10. Bloomberg, iCapital Investment Strategy, with data based on availability as of Jul. 122, 2024.
11. Cambridge Associates, FactSet, iCapital Investment Strategy with data based on availability as of Jul. 11, 2024. Note: Data as of Mar. 2022.
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