Private Market Performance in Recessions

By: Gridline Team | Published: 05/11/2022
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2 minutes

2020 and 2021 witnessed unprecedented quantitative easing to pull economies out of a pandemic-induced downturn. The printing presses were running around the clock and it worked, leading to an incredibly fast economic recovery and a soaring bull market.

After seeing inflation spike to four times the target, central banks have taken their foot off the gas, and are now going in the other direction. They are tightening monetary policy and withdrawing stimulus, leading many to worry about another economic downturn.

Historically, out of 9 recessions since 1961, interest rate increases have led to a recession 8 times. With the US Fed increasing rates by the largest amount in 22 years, and many more central banks following suit, it’s no wonder that people are worried about a repeat of the past.

Private markets, however, can provide resiliency in downturns. They are not as vulnerable to the same interest rate volatility as public markets, and they offer opportunities for investors to make money when others are losing it.

Private Markets Outperform in Recessions

When the economy takes a turn for the worse, private equity investors can take solace in the fact that their investments have historically outperformed public equities during downturns.

This was borne out during the dot-com bubble of the early 2000s and the Great Financial Crisis (GFC) of 2007-2009. Private equity funds fared better than public markets in both cases, with a less significant drawdown and quicker recovery, as shown in a Neuberger Berman Group study.

During periods of economic uncertainty, private equity’s focus on long-term value creation can be a major advantage. Private equity firms are not as beholden to the ups and downs of the stock market and can take a more patient approach to investments.

In addition to outperforming stocks in periods of economic decline, private equity has also proven to be more resilient to catastrophic loss.

As an Investments and Wealth report highlights, only 2.8% of buyout funds experienced catastrophic loss during recessions, while 18% of buyout deals lost 70% or more of their paid-in value. In comparison, 40% of stocks experienced catastrophic loss during the same periods.

Why Does PE Outperform?

There are several factors explaining PE’s outperformance during recessions. One is that private markets are characterized by longer holding periods than public markets, which allows for a more patient and active investment strategy. Further, PE firms have an asymmetric information advantage, with access to a deep bench of talent and resources. Additionally, PE firms are typically well-capitalized, with dry powder that can be used to alleviate financing concerns and help renegotiate loan terms and debt obligations.

Moreover, the common buy-and-build approach used by PE firms can be particularly effective in down markets. This approach allows for the acquisition of add-on businesses at low prices, which can then be integrated into the portfolio company to drive efficiencies and cost savings. Additionally, sector specialists with experience in a specific industry are often able to navigate through market cycles better than generalist investors.

Finally, the relative illiquidity of private markets can actually be protective in times of economic downturn. This is because panic selling is less common in private markets, as investors are typically more committed to the long-term success of the investment.

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