Key takeaways
- Private equity performance has remained resilient while favoring less interest-rate sensitive segments.
- Deal-making activity has cooled considerably, although an uptick in Q2 foreshadows revitalization.
- The coil of activity has been compressed and will be released. 2025 appears poised for acceleration.
Even seasoned PE managers and investors who appreciate the importance of a long-term time horizon have had their patience tested over the past two years. However, we see vital signs improving in a comatose market with a flywheel ready to set money in motion.
The Fed’s attempts to cool the economy have not been apparent in all sectors but most certainly have been in private equity. The impact to investment returns has been muted as the U.S. economy repeatedly outperformed consensus forecasts, yet the effects can be seen clearly as returns for those most reliant on leverage have languished.
While performance has been resilient, higher rates successfully chilled deal-making, with 2023 M&A volume the second lowest in the last ten years (2020). Foreshadowing the two years to come, deal volume and exits plunged the very quarter the Fed began their hiking campaign (Q1 2022). Rate cut expectations have now risen, and optimism for activity is growing. Supportive capital markets have given a 100bps shadow cut as spreads tightened and the syndicated loan market reopened. After a modest start to the year, M&A ticked higher in Q2 as lenders financed small deals at an increasing share.
In our view, the remainder of 2024 is poised to be a period of reorientation. Ample dry powder sits ready for deployment and unrealized value awaiting exit is at all-time highs. As Q2 showed, even modestly cheaper financing can spur activity, providing a bullish impulse for activity in late 2024. However, a durable rebound in deal activity may require further confidence that lower financing rates have some permanency. The market has moved in that direction, as forecasts for rate cuts have climbed to 250 bps by year-end 2025. Still, we expect the Fed to be methodical as long as the economy remains resilient and inflation data bumpy.
For 2025, we see activity accelerating materially. The pressure is mounting for PE managers to deploy dry powder, and we expect the combination of lower base rates and rising activity in the secondary market to set deals in motion.
