PART I: Private Markets Current Dynamics

2023 emerged as a year marked by uncertainty and turbulence, impacting both the public and private markets. While most investors would wish for Goldman Sachs' rather optimistic stance — "The hard part is over"  — to materialise, the cautious view adopted by JP Morgan - "Too early for a victory lap" — appears more resonant in the current climate. There is still a looming potential for a surge in company failures across all sectors, driven by increased financing costs, constricting budgets, and less cash to burn for "growth at any cost" mantra companies. Consequently, this landscape presents unique investment opportunities that arise perhaps only once in a decade. The distinction becomes clearer between those buoyed by the forgiving tides of a bull market — where losing seems improbable — and the seasoned investors who navigate this tougher market with skill and foresight.

Private Markets 2023: in the Nutshell
The private markets came a long way in the past decade, with capital under management reaching $13tn in 2022, according to Apollo, far surpassing the percentage growth of fixed income and equities. After a decade of tremendous growth, 2023 proved to be a challenging year with fundraising going down by almost 30% compared to the heights of 2021. And yet, the dry powder stood at all time high at $3.9tn and some of the managers raised their largest funds ever in 2023.

Consistent Commitment Pacing is Key
The opinions vary on the drivers for the fundraising slowdown but two key factors most agree on: heightened level of uncertainty and turmoil in the public markets. The lack of track record, one of the main criteria for LPs to invest, decreased the chances of newer GPs raising capital. However, potentially more significant impact came from public markets and the denominator effect. When public markets tanked mid-2022 and private markets valuation remained relatively stable, it send ripple effects in the finance industry. As a result, the portfolio managers found themselves over-allocated to private markets coupled with very uncertain market environment and rising interest rates. Some investors decided to wait to get more clarity and many were forced to, by their strategic asset allocation mandates. Having said that, nobody wants to wait for too long. For one, the research shows that consistent commitment pacing is a key in seizing opportunities in private markets in times of uncertainty. According to research from Vanguard, it offers anywhere between 17% and 34% higher payoff than decreased or paused commitment pace in times of uncertainty. Another research piece from Neuberger Berman argues that whilst US Buyouts and the S&P 500 saw troughs in roughly the same period, a diversified private equity portfolio was able to recover much sooner than the S&P 500. With public markets getting back on track, denominator effect fading away and more adequately priced investment opportunities, there will be a renewed interest in private markets from the institutional investors.

Incentives of Industry Players
The economic uncertainty and higher interest rates in 2023, led to the global M&A activity plunge to a decade low of $3tn, with private equity-led buyout volumes globally plummeting by 38% to $433.6bn. This meant lower liquidity and lower DPI to private markets investors but also historically lower fees to M&A advisors and lawyers.

As 2024 commences, there will be more restlessness from LPs to get some liquidity back to increase DPI and to redeploy capital in this opportune time. The GPs will be very much incentivised to get the transactions going, not only to provide liquidity to LPs, but also start deploying that huge pile of $3.9tn dry powder, on which the clock is ticking. Some of the quality assets might attract interest of strategics with pent-up demand from buyers and desire to innovate through M&A. The recent CEO survey from PwC showed that 70% of business leaders expect to use M&A to accelerate adoption of technology and technology-related processes.

Another important path to liquidity will be secondary transactions, the trend that started in 2021, was at $114bn in deal volume in 2023 and is expected to continued well in 2024. Lastly, the opportunities will arise for turnaround and distressed buyers that have been waiting for this of market conditions for the past 5 market years. Regardless of the path chosen there is enough incentives around the table to get reinvigorate M&A and private equity transactions.

Investor Beware
There will be an abundance of investment opportunities in 2024, they key is to identify the good ones. The days are gone when leverage was a key value driver and everyone looked good-ish in the bull market. The key skills at the GP level will be to add value beyond capital and help the existing portfolio companies to weather the storm. The recent paper from Goldman Sachs showed that leverage had significantly lower impact on value creation in post-GFC private equity funds and the main driver was market multiple expansion, i.e. run-up in public company multiples. The main task for GPs will be to demonstrate they can create value beyond these factors.

At the LP level, the name of the game will be to incorporate new found market dynamics into their investment due diligence, pay closer attention to data, ask challenging questions and find an efficient process to deal with troubled parts of the existing portfolio.

For the players that learn to navigate in a very different macro environment and succeed, the future looks very bright. Especially if interest rates are cut three times in 2024, then it is just cherry on the cake.

To Wrap-up
We believe that institutional investors will be keen to come back to private markets in 2024 in order not to miss on the best investment opportunities, whilst incorporating additional factors into their due diligence on what worked, what did not and what has changed. The incentives from different industry players will drive the transaction volume back whilst adapting to a new private markets dynamics from abundance of capital to more selective approach, and yet plentiful available to quality businesses and GPs.  

We are not saying that the tough part is over, there is potentially more to come in terms of distressed businesses, down rounds, unwanted capital calls and yet it also potentially once in a decade opportunity to invest and redefine the next decade as an investor. And as for new LP investors, it is as opportune time as ever to start with more meaningful data points to evaluate GPs, more reasonably priced investment opportunities and no prior portfolio to deal with in this market. More on this later.