Calling all LPs!

Welcome back and thanks for joining me (John Bailey, Co-Founder at OneFund) for the fourth edition of Capital Call. A bi-weekly private equity newsletter from LPs for LPs. 

Capital Call delivers concise, top-notch insights and updates from the private markets tailored to what matters for LPs. 

This week I: 

• Break down Pitchbook’s latest Global Fund Performance Report and cover what it means for LPs.

• Highlight some notable updates and fundraises from across the ecosystem.

• Cover the latest insights from leading GPs.

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Private Fund Performance Insights

Earlier this month, PitchBook released their latest Global Fund Performance Report covering private fund performance for Q3 and Q4 of 2022. As expected with broader market uncertainty, preliminary Q4 2022 data shows PE and VC funds’ quarterly horizon IRR at -0.2% and -0.8%, respectively. 

Despite negative 1-year headlines, LPs can take comfort in knowing PE/VC strategies are still top performers at the 3-year and 5-year level and have mostly avoided the public market volatility seen in the MSCI World Index’s drop of -18.1% last year. 

Within the data, here’s what I’ve identified as important to LPs.

A Refocus Towards The Fundamentals

The current macroeconomic backdrop undermines one of private equity’s key returns drivers: financial engineering. Previously cheap debt and extensive leverage capacity have shifted to high-interest rates and a tighter credit market.

Now, GPs are focusing primarily on EBITDA growth rather than leverage and multiple expansion. If LPs wish to continue realizing the high returns of 2020 and 2021, they must look at GPs with strong operational experience to pursue organic growth. 

Geographically, North American private equity funds have remained stronger, returning 5.9% in Q3 2022 compared to -7.3% globally. This is due to higher buyout multiples as a result of stronger deal competition, a more developed investment industry, and the resilient tech sector. According to Pitchbook, LPs should expect U.S. GPs to continue outperforming slightly in the medium term as these market factors are expected to hold.

A Dead IPO Market: A Disproportionate Impact on Large Managers 

The current IPO market is essentially frozen, with 2022 being the worst year since 1990 (according to Axios).

Even if IPOs were feasible in today’s environment, sponsors may not even want to pursue them as the historic significant premium applied to public multiples no longer exists, removing a key return lever for larger funds. Public and private multiples could converge more permanently over the long term with the rapidly growing allocation towards private equity.

The above Pitchbook chart shows a reversal in the historical trend of large managers achieving higher IRR yields as funds managing below $250 million are now the top performers. This is likely compounded by the fact that “mega buyout” deals are harder to structure with the current credit environment and that middle-market deal share is at record highs. 

With these trends, LPs who have traditionally flocked to the largest GPs due to their perceived safety and track record may want to consider adding mid-market strategies to adapt to current conditions and diversify. Smaller PE firms that are strong operators with a history of growing EBITDA are positioned well in today’s market.

If you enjoyed this read and have any questions or would like to discuss further, feel free to schedule a call with us - we’re happy to chat.

Updates from Across the Ecosystem

Fundraising

📈 Ares Expects to Secure $3.5bn in Pathfinder Fund II’s First Close

📈 Pacific Avenue wraps up Maiden Fund at over $500m

📈 TPG Tech Adjacencies II fund raises $3.4 billion

Reports

🔬 PitchBook Analyst Note: The Evolution of Private Market Secondaries

🔬 Fidelity IPO Outlook

GP Perspectives

Jason Thomas and Mark Jenkins (Carlyle)

Earlier this month, Carlyle released their 2023 Credit Outlook. It’s aptly named “New Landscapes, New Eyes” as it discusses the new lending landscape caused by interest rate hikes. Here are some key themes discussed:

1. Challenged Arithmetic for Sponsors

As discussed earlier, deal economics have been stressed due to higher interest rates and Carlyle does an excellent job of visualizing the mechanics. 

1. Opportunistic Credit Steps In

Another shock of credit markets Carlyle identifies is that private lenders are taking financing volume over syndicated loans and bonds. Though a positive for private credit funds, it comes at the expense of sponsors and reduces the liquidity of the broader market. 

They also note opportunistic credit is trending with deal structures where lenders are priced to earn 14% to 16% through payment-in-kind (PIK) financing. Carlyle believes these structures may become the “new normal” and that 2021-level financing may not return over the foreseeable future.

Andrew Wilkinson (Tiny)

Andrew, the co-founder of Tiny, brings up an interesting point. With the downtrend in VC performance, many funds may be looking to unload their more modest growth portfolio investments in favor of focusing on “moonshots” that will save their performance figures. Perhaps this will end up creating opportunities for PE managers operating lower on the risk spectrum.

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