Private Equity Co-investments | Manulife Investment Management

Key takeaways

The private equity market has effectively been on pause since mid-2022.
Buyers are becoming desperate to deploy, and sellers are becoming even more desperate for distributions.
We believe valuations will fall further, activity will rise, and 2024 will present an attractive entry point.

Private equity investors have plenty of wild cards to contend with in the year ahead. A short list would include wars in Ukraine and the Middle East, a pivotal U.S. presidential election, a real estate crisis in China, unpredictable climate-related events, and growing cybersecurity threats. And then there’s the economic backdrop: Sharply higher interest rates are beginning to take a toll. The key question has shifted from How high will they go? to How long will they stay here?

LPs are desperately seeking distributions

Source: PitchBook, September 30, 2023.

Merger and acquisition activity has come to a virtual standstill. Deals are hard to come by and exits even harder. The private equity market is still trying to adjust to this new and more uncertain macro environment. This adjustment period has been a long and frustrating one, reaching back to mid-2022: As the cost of credit increased rapidly and the availability of credit—particularly for larger deals—declined, deal activity slowed considerably. Valuations remained largely unchanged for a while before beginning to fall in 2023. For new transactions, this trend has accelerated in recent months.

Relative to public markets, price-to-earnings (P/E) multiples have moderated meaningfully. Meanwhile, with platform activity still depressed, sponsors have been focused on driving value through add-on activity and operating improvements. New deals, when they occur, are being financed with higher equity contributions, reaching new highs in equity/capitalization ratios.

Looking to 2024, valuation capitulation is our expectation: We believe valuations will continue their current downward path toward fully incorporating the new macro environment. In conjunction with a more settled rate environment and more constructive credit markets, lower valuation multiples should result in a significant pickup in deal activity. At the same time, slower economic growth will be a headwind for many industries next year, putting management and sponsor value creation at a premium. Pricing power will likewise be critically important to maintaining margins and driving value in a more inflationary environment. In evaluating private equity co-investment opportunities, favor less economically sensitive industries. Seek good businesses backed by great sponsors focusing on mitigating macro pressures by targeting operating efficiency. In the final analysis, consistently allocating capital to the highest returning asset class matters most.

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