For those wanting pension funds to invest more in private equity, a new report showing the asset class consistently outperforming listed markets during the largest market crises of the past 25 years will be music to their ears.
This has been revealed by Schroders Capital, which undertook a study of private equity performance within a broad analysis of the past since 1999. This was a period that saw five major financial crises: the dot-com crash; the global financial crisis; the Eurozone crisis; Covid; and the return of inflation.
Amid this turbulence, private equity managed to deliver impressive absolute and relative performance and outperform public markets, according to Schroders Capital.
Putting numbers to this case, global private equity outperformed the MSCI ACWI Gross index during each of the major disruptions with an average annualised excess return of 8%, according to the research.
In addition, when comparing performance to the S&P 500 Total Return index, global private equity also consistently outperformed during all five crises, with an average outperformance of 4%. And the maximum quarterly drawdown over the five periods averaged -18% compared to the -31% drawdown of the MSCI ACWI Gross index.
Even in the depths of the dotcom crash of 2000, where private equity was challenged due to its exposure to early-stage technology companies at the heart of the bubble, it still fared better than public markets.
And amid the uncertainty surrounding Covid, private equity achieved annualised returns of 18%, while public markets delivered only a 2% return.
Furthermore, global private equity has delivered a compound annual return of 12% during the past 25 years, outperforming the MSCI ACWI Gross, MSCI World Gross and S&P 500 Total Return indices.
Resilience
The key driver behind this outperformance has been the resilience of private equity during crises, the research said. Private equity delivered an annualised excess return of 8% during the five crises and half this during undisturbed periods.
Interestingly, all private equity strategies performed consistently well throughout the eurozone crisis, including in Europe.
However, in each of the other crises, diversification was key to achieving resilient returns.
Furthermore, small/mid buyouts were the best performing strategy or among the best performing strategies in four of the five crises. There has been, in some crises, divergence of performance within private equity. During the financial crisis, global private equity declined by 6% per year, outperforming the MSCI ACWI Gross index, which fell by 9% annually.
Small/mid buyouts were the least impacted, dropping only 4% per year due to their lower reliance on leverage at a time of tight liquidity. In contrast, large buyouts were the worst performing strategy, with an 8% annual decline.
Additionally, private equity returns in Asia and the rest of the world were negatively affected by weaker domestic growth, particularly impacting buyouts.
And notably, after a bumper 2021, venture capital/growth became the worst performing strategy in 2022, declining 20%. However, this was still a superior performance when compared to the Nasdaq Total Return, which was down 32%.
In four of the five disruptions were characterised by boom-bust scenarios. Venture capital/growth was the best performing strategy throughout the dotcom bubble ahead of the crash.
However, after the collapse in technology valuations, it became the worst performing strategy by the end of the disruption. Similarly, in the lead up to the financial crisis, buyout funds raised substantial amounts of capital, and many small/mid funds ballooned into large funds.
However, when liquidity dried up, large buyout funds with highly levered portfolio companies experienced significant drawdowns and negative returns.
Private equity lag
And any comparison of public and private equity returns is influenced by valuation methodologies, as there is often a lag before private equity valuations are updated, noted the research, with private equity valuations experiencing a one-quarter lag to public markets.
To account for this, Schroders Capital extended the returns calculation window by an additional quarter.
It should also be noted that the private equity industry changed considerably from the dotcom crash in the early 2000s to the return of inflation in 2022 in terms of regulatory and accounting considerations, which could impact historical comparisons.
The financial crisis served as a catalyst for introducing more rigorous fair value assessment practices, potentially resulting in private equity valuations having had less frequent mark-to-market assessments prior to that period.
Nils Rode, chief investment officer at Schroders Capital, said: “This analysis highlights private equity’s potential as a robust component of investment portfolios, especially during periods of economic uncertainty.”
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