Calling all LPs! Thanks for joining me (John Bailey, Co-Founder at OneFund) for another edition of Capital Call. A bi-weekly private equity newsletter from LPs for LPs. 

The mission of Capital Call is to deliver concise, top-notch insights and updates from the private markets tailored to what matters for LPs. 

This week we will be looking at: 

• Q2 Private Equity Update

• Fundraising updates and VC/PE reports

• GP Perspectives from Howard Marks & Otavio Costa

Join me for our upcoming webinar!

This Friday at 12 p.m. join me for our upcoming OneFund x Guardia webinar, Navigating Private Equity! Miguel Osio Brillembourg is a good friend and the Founder of Guardia, a concierge platform helping individuals better navigate their financial lives.

I'll be grilling Miguel on private vs public, risk premiums and pesky lock-ups.

All jokes aside, I’m really looking forward to the discussion. This exclusive webinar will be this Friday, September 22nd at 12 p.m.

Q2 Private Equity Update

Private equity deals rose 15% in the second quarter of 2023 versus Q1, resulting in US$114b in deal value according to EY. This results in US$213b worth of deals in the first half of 2023, which is similar to 2H 2022 but still significantly less than the US$545b of deals in the first half of 2022. Macro concerns still heavily dampen deal activity as GPs face uncertainty over interest rate hikes and the state of the economy. But at the same time, volatility is easing as the S&P 500 rose more than 8% in Q2 and investors are turning more opportunistic. In this week’s Capital Call, I'll cover the key themes EY uncovers in their mid-year PE report and provide the key takeaways most relevant to LPs.

Take-Privates are Cooling as Deal Activity Normalizes

Take-private transactions were heavily favored in Q1 of this year, making up a staggering 68% of all PE deals, but that figure dropped to 42% in Q2. Though this is still high compared to the historical average, it will continue to drop as firms shift away from ‘bargain-hunting’ in the public markets to focusing on broader deal structures. Much of this new deal activity involves secondaries, carve-outs, and standard private market acquisitions, which have seen muted deal flow until now. LPs should expect GPs to progressively deploy more capital than in previous quarters as deal activity may continue to recover.

Much of the uptick in private M&A was driven by a modest rebound in exit activity, with transactions valued at US$84b in Q2, up 42% from Q1. Almost all deals this quarter were strategic in nature, demonstrating the continued emphasis on fundamental investing as a result of current market conditions. The IPO market, while seeing some uptick this quarter, remained mostly closed in Q2, with the exception of some high-profile IPOs. Just thirteen companies backed by GPs completed IPOs in H1 2023. Though exit activity hasn’t fully recovered, there are certainly opportunities for sales and LPs should ensure their GPs are actively considering all liquidity options, especially now that sales to strategics are regaining momentum.

LP distributions as a percentage of NAV have fallen to their lowest levels since the GFC

Unsurprisingly, LP distributions are now just 14% (26% historical average), the weakest levels since the GFC. As a result, both LPs and GPs are considering the secondaries market for liquidity with a survey finding 75% of investors intend to use secondaries over the next two years. This is causing rapid fundraising in the secondaries fund market, which raised over US$32 billion this year despite the difficult environment. Much more fundraising is expected for secondaries in the coming months, and LPs should consider whether gaining exposure to this growing market aligns with their investment needs.

Tech, Health Care, Consumer, and Financials Dominate

Tech’s continued prominence was clear last year, with over 25% of PE’s total spend, but that figure has grown even higher to over 33% in the first half of 2023. While this may feel odd in an environment with relatively high-interest rates, I believe this is representative of the unavoidable benefits of and the secular trends in tech. One driver of this, for example, is the heightened focus on cybersecurity as all firms continue increasing cyber budgets. Cyber providers are seeing high PE interest due to cybersecurity’s low client churn, high margins, and industry tailwinds.

Healthcare saw an uplift this year due to interest in specialty medicines, direct-to-consumer drug models, and other growing spaces. For consumer-focused targets, a key focus was on carve-outs in the packaged goods and agribusiness sectors where companies had room to grow using tech integrations. 

GPs and LPs alike should note that a key underlying trend behind the growth in healthcare, consumers, and financials is tech integration and services. Many firms in these sectors, especially hospitals with outdated patient record systems, desperately need to execute basic digitization initiatives. GPs operating IT services and software portfolio companies should consider whether their services can be applied to these adjacent industries to realize further tailwinds. 

Updates from Across the Ecosystem

Fundraising

📈 H.I.G Capital racks up $5.5bn for fourth mid-market LBO fund

📈 Centerbridge seeks $3.5bn for fifth flagship PE fund

📈 Blackstone raises $5.2bn for fourth Tac Opps fund

Reports

🔬PitchBook: Analyzing the IPO Market Outlook

🔬KKR: The Changing Role of Private Real Assets in the ‘Traditional’ Portfolio

🔬Bain’s Latest Macro Update Podcast: Are We Out of the Woods Yet?

GP perspectives:

Howard Marks (Co-Chairman, Oaktree)

Howard Marks provides a useful illustration of the risk-return dynamic. The traditional risk-return spectrum shows expected returns climbing higher as we move up in risk tolerance, which is true, but suggests taking risks always increases returns while not showing the higher return volatility. Marks’ graph above shows the true nature of shifting to riskier strategies.

This leads Marks to pose the question: Should investors target fewer losers or more winners? In reality, there’s no right answer since you need to find your own favorable relationship between winners and losers. Neither maximizing winners nor minimizing losers is enough since it’s all in the balance and strategies should remain dynamic. Marks explains that in periods of excessive risk aversion, the riskier part of the curve can be the smarter place to be and vice-versa for periods of excessive risk taking.­ When everyone is zigging, zag.

The final choice depends on each investor’s skill, return aspiration, and risk tolerance. LPs must ask themselves where along the curve they want to be and allocate among their public and private portfolios accordingly.

Otavio Costa (Partner, Crescat Capital)

Otavio Costa observes that the slowdown in inflation is likely responsible for the substantial capital inflows into the tech sector this year. Inflation is probably bottoming out, and recent developments in commodity prices are reflecting this.

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