Is European Private Equity at a Turning Point? UBS Inquires

European private equity is currently at a pivotal point, as highlighted by UBS, which outlines several critical questions that could shape its future.

How quickly will deal volumes recover now that interest rates are declining?

Activity within private equity deals has started to improve, although it remains at about half of the historical average. UBS suggests that falling interest rates, which lead to lower financing costs, combined with an economic ‘soft landing,’ should foster a recovery in deal activity.

The bank anticipates a rebound from the lows observed in 2022, 2023, and the first half of 2024. However, they estimate that global private equity deal values would need to double from current levels to return to more typical figures, which could prove challenging. This situation may necessitate the private equity industry to adopt more innovative and flexible strategies for divesting assets. Analysts mentioned that an increased focus on trade sales, secondaries, and IPOs may need to supplement the traditional emphasis on sales to other financial sponsors. Additionally, a willingness to accept lower exit valuations may arise as part of this transition.

Can private equity maintain a high internal rate of return (IRR)?

Rising funding costs, along with potential valuation adjustments aimed at stimulating deal activity, could impact overall returns, according to UBS. The private equity sector lacks a definitive benchmark for achievable returns in a standard interest rate environment. UBS forecasts that the top private equity firms will be those capable of sustaining optimal returns by enhancing the operational performance of their portfolio companies and identifying unique, tailored deals.

Is there potential for private equity fundraising to experience structural growth?

UBS believes that a resurgence in fundraising is indeed possible, though two challenges could hinder rapid progress. First, lower absolute IRRs may diminish investor interest in escalating allocations to the sector. Secondly, with private equity capital call rates exceeding distribution rates, it may take time for the over-allocation experienced during recent cash flow disruptions to adjust, making it harder for limited partners (LPs) to increase their allocations in the short term. The bank concludes that private equity distribution rates may need to remain at double the current level for at least a year to allow cash flow models to stabilize.

Is private wealth a viable fundraising opportunity to foster continued growth in assets under management?

The vast potential market suggests that private wealth could offer a significant new fundraising avenue for the private equity industry. Current discussions among investors revolve around whether this growth is essential to mitigate existing challenges to institutional LP allocations, fund expansions, and possible fee margin pressure, or if it can genuinely serve as an independent growth catalyst for the sector.