Headlines purporting the demise of VC and private equity markets are overblown and fail to appreciate the historical resilience of private markets. A closer examination of the industry reveals a much more optimistic reality, with significant growth in retail investment, exceptional PE performance, and rapid expansion of sectors like private debt.
This article will also explore the factors contributing to private market outperformance, such as the liquidity premium, M&A opportunities, a larger investment universe, and longer-term orientation.
Private Markets: Exceptional Performance
Private equity has consistently outperformed other asset classes. In fact, McKinsey research shows that the median net IRR for 2009–19 PE fund vintages were 20.1 percent, surpassing the top-quartile return of all other private asset classes by over 200 basis points. Top-quartile PE funds have been particularly impressive, with net IRRs reaching 29.8 percent or higher.
Another area of significant growth within the private market landscape has been private debt. Private debt has experienced the fastest growth among all private asset classes. Global fundraising reached a new high of $224 billion, marking a 2.1 percent year-over-year increase and the fifth consecutive annual rise. Since 2013, annual fundraising in private debt has more than tripled, growing at an impressive annual rate of 12 percent.
The surge in private debt can be attributed to factors such as increased demand for alternative sources of financing, regulatory constraints on traditional lenders, and the search for yield among institutional investors.
Now that we have explored the growth and performance of private markets, let’s briefly highlight the key drivers that contribute to their outperformance.
Key Drivers of Private Market Outperformance
One of the most significant contributors to the outperformance of private markets is the liquidity premium. Private market investments often come with higher returns due to the illiquid nature of these investments. Investors are rewarded with a premium for the additional risk of reduced liquidity. This premium encourages them to commit their capital to long-term projects that may offer higher returns.
Another key driver of private market outperformance is the ability to capitalize on economic downturns by seizing M&A opportunities, restructuring distressed assets, and investing in companies at discounted valuations. This ability to act decisively and strategically during challenging economic periods allows private market investors to enhance their portfolios and generate value over the long term.
Further, private markets have access to a broader range of investment opportunities, including small and medium-sized enterprises that are not publicly traded. This larger investment universe allows private market investors to be more selective in their investments, targeting companies with strong growth potential that are not yet accessible to public market investors.
Moreover, many companies are choosing to remain private for extended periods, allowing them to focus on long-term growth and avoid the short-term pressures of public markets. This trend provides private market investors with a larger pool of high-quality investments and the opportunity to work closely with management teams to unlock value and drive growth. By collaborating with companies prioritizing long-term objectives, private market investors can better align their interests and maximize returns.
Retail Investment: A Growing Opportunity
The same McKinsey report highlighted earlier shows that the retail investor market is worth $45 trillion, but allocations to private markets range only from 5 to 6 percent. This untapped source of funds could significantly bolster VC and PE investments, providing a promising avenue for growth and demonstrating the resilience of private markets.
As retail investors become more aware of the potential returns in private markets, we can expect their allocations to increase, leading to a greater inflow of capital and supporting continued growth in the sector.
Takeaways
The resilience and strength of private markets stand firm, despite headlines suggesting otherwise. With retail investment on the rise, private equity demonstrating exceptional performance, and private debt experiencing unprecedented growth, there are strong reasons to be optimistic about the future of private markets.
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