Private Equity Outlook: How Long Will the Boom Last?

Private Equity Leaders Discuss Market Trends and Future Outlook

Earlier in the day, during an exclusive event, this reporter had the privilege of engaging in conversations with prominent figures in the private equity sector. These included David Rubenstein, a co-founder of Carlyle; Steve Pagliuca, co-chair of Bain Capital; Jean Salata, the CEO and founding partner of Baring Private Equity Asia; and Sheila Patel, the vice chairman of B Capital Group AGM, formerly holding the chair position at Goldman Sachs Asset Management.

Discussions spanned a wide range of topics, from the level of interest in blockchain technologies among these firms – opinions varied – to their commitment to sustainable and socially responsible investing. Rubenstein asserted that “private equity firms are placing significant emphasis on this area,” and forecasted that the emergence of a financial metric for evaluating companies based on these criteria “within the next five years” would lead to its widespread adoption.

Patel, who previously contributed to Goldman’s inclusion and diversity initiatives, concurred, highlighting that over one-third of investors currently find it challenging to accurately measure Environmental, Social, and Governance (ESG) criteria, though she anticipates a rapid improvement in this capability.

The current market conditions were also a key focus, including how firms distinguish their services in an environment where capital is readily available, and their expectations for the duration of the current high-growth period. Interestingly, the private equity executives suggested that the robust market activity could potentially extend well into 2023, or even beyond, a perspective that may surprise some.

A complete transcript of the interview is reserved for event attendees, but key insights from the latter portion of the conversation are summarized below:

Steve Pagliuca:

A contributing factor to our current success has been substantial government intervention, which was, in my view, justified. As this support diminishes, we may observe a corresponding effect. The current unemployment rate, exceeding 5.2%, is remarkably low considering the ongoing pandemic, and numerous job openings remain unfilled.

This situation is partly attributable to government payments, which reduced the immediate need for some individuals to seek employment. Consequently, we might anticipate a further decrease in unemployment as these payments cease, and this impact will be a crucial consideration.

David Rubenstein:

The present times are simultaneously the best and worst. For investors, particularly those involved in technology, investing in India, China, and the United States, it represents a period of exceptional opportunity. This can lead to a sense of accomplishment, but it’s crucial to recognize that these conditions contrast sharply with the realities faced by those lacking internet access, relying primarily on manual labor, or facing challenges related to education and childcare.

Unfortunately, we are witnessing a widening economic divide and increasing income inequality, alongside a decline in social mobility, both in the United States and globally. While current prosperity may not endure indefinitely, the Federal Reserve will likely raise interest rates – potentially not before 2023 – and investors may begin to reduce their exposure at prevailing valuations. I recently participated in a discussion concerning a deal in Asia where valuations reached 25 times projected revenues.

Jean Salata:

Valuations are inextricably linked to the current interest rate environment. While interest rates will inevitably rise at some point, the Federal Reserve’s recent bond purchases, totaling approximately $4 trillion over the past 18 months – currently around $120 billion monthly – are suppressing rates. This compels investors, including pension funds, endowments, and individuals, to seek investment opportunities to generate returns.

Current valuations are likely in the 99th percentile or near their peak in terms of multiples. However, when considered relative to rates and earnings yield, less the 10-year Treasury rate, they may only be in the 20th or 30th percentile. Reflecting on the experiences of 1999 and 2000, while valuations exhibit similar frothiness in terms of multiples, interest rates were then around 5% or 6%, compared to the current 1%. This difference is substantial.

Underlying structural factors, including income inequality – a significant issue worldwide, even in China – are also at play. Individuals with financial assets benefit from the Federal Reserve’s bond purchases, driving up valuations and increasing savings rates. Higher savings rates, resulting from reduced spending needs, further depress rates. Therefore, even as the Fed begins to taper its bond purchases, I anticipate rates remaining lower than historically, potentially supporting elevated valuation levels for an extended period.

Steve Pagliuca:

Considering the escalating national debt, applying a 5.5% interest rate would result in interest payments consuming nearly half the federal budget. Consequently, I doubt politicians will advocate for substantial interest rate increases. Instead, they will likely maintain low rates for as long as possible, as tax increases would be significant if rates returned to historical levels. The ability to manage spending is facilitated by low rates, suggesting a continuation of this trend, which will support current valuations.