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Private equity's stability and sentiment appears directly connected to the state of play in public markets. Market participants will be watching how private markets respond to the evolving macroeconomic and credit conditions shaping public markets in deploying dry powder—especially after private equity (PE) firms accumulated a record $2.62 trillion of total uncommitted capital in the first half of this year, according to data from S&P Global Market Intelligence and Preqin.

As investors increasingly allocate capital across private markets, evolving macro-credit and financial conditions may require a need for greater transparency. In this edition of Private Markets Monthly, Global Head of Private Markets Analytics Ruth Yang explores how private equity reacts to activity in the public markets—with S&P Global Ratings' Beth Campbell, director & lead analyst for asset management, and S&P Global Market Intelligence's Ilja Hauerhof, director of quantamental research and solutions for private markets.

Looking at private equity, what interplay between public and private markets are you currently seeing?

Beth Campbell, director & lead analyst for asset management at S&P Global Ratings: 

In our view, healthy public markets are important to drive PE monetization activity. We see this across our portfolio of 18 alternative asset managers that we rate globally—including Apollo, Ares, Blackstone, Carlyle, and KKR. Private equity realizations slowed to a trickle over the last couple of years as higher-for-longer interest rates hurt valuations and the IPO market stalled. Opportunities for PE sponsors to sell portfolio companies to strategic buyers or to another sponsor have also been hindered by these macro conditions. Private equity exits and, as a result, distributions and returns of capital to limited partners (LPs) remain subdued.

Ilja Hauerhof, director of quantamental research and solutions for private markets at S&P Global Market Intelligence: 

Our research shows that stable public markets are the secret to private equity optimism. Our natural language processing analysis of statements made by executives of 28 publicly-traded private equity firms during first quarter 2024 earnings calls revealed a significant rebound in PE confidence over the last two years. Despite a challenging M&A landscape and slower fundraising environment, PE executives' sentiment surged to its second-highest level in over 13 years (or 57 earnings seasons)—underscoring the inverse relationship between market turbulence and PE industry morale.

Beth Campbell:  With some institutional investors at or above target allocations to PE, we don't expect a lot of new money flowing into PE funds until the flywheel of fundraising, deployment, and exit starts moving again. That said, we have seen growth in PE secondaries providing some liquidity. And alternative asset managers have significant dry powder available to deploy opportunistically. However, an abundance of dry powder chasing the same deals may keep valuations high in the near future within the PE world.

Ilja Hauerhof:  In the current high interest rate environment, private equity firms are strategically focusing on liquidity to manage higher borrowing costs and support their portfolio companies. This focus becomes critical when navigating a challenging exit environment and attracting and retaining investors, who seek to balance their exposure between illiquid and liquid markets.

Overall, private equity executives spoke less about inflation, interest rates, and liquidity during first-quarter earnings calls, than they have in the 10 previous quarters, suggesting some reduced tension (albeit with ongoing importance) around these topics. Notably, mentions of 'volatility' on first-quarter earnings calls were down 74%.

How are PE firms changing their fundraising strategies in response to current macroeconomic and credit conditions?

Beth Campbell:  One area we see growth is in PE products for the wealth channel, which targets eligible individual investors.

Ilja Hauerhof:  Although macroeconomic headwinds have created a tougher fundraising environment for private equity firms, 'fundraising' discussions remain prevalent among publicly-traded private equity firms—which are increasingly targeting high-net-worth individuals to fill fundraising gaps. Mentions of 'private wealth' emerged in third-quarter 2021, doubled by first-quarter 2023, and remained elevated through first-quarter 2024, according to our sentiment analysis.

Beth Campbell:  We also see some alternative asset managers having success fundraising for regionally focused opportunities (outside of the U.S.), such as PE Asia funds. And we've seen asset growth in sector-targeted PE funds—like energy transition or infrastructure, which may include digital infrastructure. In addition to growing through regional and investor-base expansions, we expect growth in secondaries.

Ilja Hauerhof:  Asset class diversification is a key focus for private equity executives, with discussions about 'private credit' more than doubling in the first quarter of 2023 and continuing to be a priority through first quarter of this year. Private credit is expected to remain a prominent topic among PE executives involved with this asset class in the upcoming quarters, despite an anticipated rise in defaults in 2024.

Beth Campbell: 

The slowdown in PE exits, and some portfolio companies facing refinancing needs, has led to expanded demand from borrowers for private credit. High-net-worth investors have contributed to the significant growth in private credit in the last few years, and regulatory considerations at banks have also created some opportunity for private credit lenders to fill gaps. The yield and diversification opportunity is attractive to LPs. Credit now comprises a significant portion of assets under management for the 18 sponsors we rate globally—with some managers laying out ambitious growth targets amid a perceived 'golden age' for private credit. This shows the real benefits to alternative asset managers of having diversified platforms.

At the same time, despite private credit's performance having been solid over the last five years, default rates will likely rise among global corporates—particularly if funding remains expensive and market dislocation hits vulnerable borrowers. A potential increase in default rates will test the asset quality of private credit funds. Private credit payment defaults rose last year as weaker borrowers struggled to service debt.

In what ways do you expect alternative asset managers' private equity business to evolve moving forward?

Ilja Hauerhof:  Discussions of 'artificial intelligence' in private equity earnings calls doubled in the first quarter of 2024 compared to the same period last year. Executives are focusing on AI's broader implementation for value creation within portfolio companies—including applications in customer service automation, predictive analytics for risk assessment, and investments in AI-driven companies and infrastructure. Surprisingly, terms like 'large language models' or 'ChatGPT' accounted for only 10% of total AI mentions in first-quarter 2024. Instead, executives predominantly used the broader 'AI' terminology.

Beth Campbell:  From an evolutionary perspective, we expect alternative asset managers will be looking to grow revenue and expand margins of their PE portfolio companies. As interest rates are unlikely to reach the very low pre-pandemic levels over the next couple of years, managers will find it difficult to boost returns with high levels of low-cost debt—as had been the case in the past. In general, though, we expect to see PE as a proportion of alternative asset managers' overall assets and earnings rise and fall, depending on macroeconomic and secular conditions.

Writer: Molly Mintz