of The Fed's move to cut interest rates should be good news for advisors with private equity allocations, especially with the promise of more cuts to come. The private equity industry has been struggling with stagnant deal volumes in recent years as higher rates have made it more difficult to secure attractive financing for new acquisitions and find exits for existing assets that would give expected returns. Industry experts said this month's cut of 50 basis points should help restart that activity.
or 2023 survey by alternative investment platform CAIS and consulting firm Mercer found that 33% of financial advisors allocate between 6% and 20% of their client portfolios to private equity, making it one of the most popular alternative assets for the industry. Most (65%) allocated private equity investments to enhance returns: no other asset class came even close to matching private equity in that function, according to the survey results. Another 31% of respondents said that private equity helped them diversify risk. When the survey was conducted in September and October 2023, 68% of CAIS and Mercer advisors surveyed planned to increase allocations to private equity and/or private debt.
However, the state of the private equity sector in the year to 2024 has been less than ideal. According to data from S&P Global Market Intelligence and London-based research firm Preqin, in the first half of 2024, only 704 private equity funds closed globally, compared to 2,590 funds that closed in all of 2023. Fundraising of private equity also looked on track to be 20% down for the full year, reaching just $365.75 billion between January and June 2024.
Deal ratings also took a hit. Private market research firm PitchBook estimates that valuations for US middle-market private equity deals fell from a high of 12.3 times in 2021 to 10.8 times in 2023.
Higher interest rates made it challenging for private equity managers to fund deals in a way that would allow them to meet their return targets, Dan Fletcher, portfolio manager within the private markets platform at investment solutions firm Russell Investments. This was especially true for larger private equity shops that rely on high leverage to drive returns.
As a result, “We expect the rate cut to provide a boost to overall private investment activity,” Fletcher wrote.
“As the industry continues to create a large amount of investment in funds that are nearing the end of their terms, we expect that lower funding costs will encourage more buyers to enter the market and drive an increase in activity.” of agreements in the coming quarters.” he added.
Even before last week's interest rate cut, sentiment at big private equity shops suggested there would be an increase in M&A and IPO activity this year as interest rates stabilized, S&P researchers found . The promise of further interest rate cuts only strengthens this outlook.
Read more on the impacts of the Fed's rate cut:
Accompanied by greater availability of credit and more positive investor sentiment, lower interest rates should allow private equity deals that were previously too expensive to execute to become viable again, according to Christopher Zook, founder and CIO of the global manager of alternative investments CAZ Investments. This should help increase transaction volumes.
“Cutting interest rates should absolutely benefit private equity investment,” Zook wrote in an emailed response. “As a result of the cuts, we would expect the volume of transactions to increase – not only because the bid-ask spread between buyers and sellers is likely to narrow, but also because of the greater availability of credit.”
However, Larry Swedroe, former head of financial and economic research at wealth management firm Buckingham Wealth Partners, cautions that the reasons the Fed is cutting rates also need to be closely examined to understand the potential impact on the private equity sector. If the impetus is primarily that the Fed thinks it has inflation under control, that would be a net positive for private equity. But the Fed may also have concerns about the broader economy, and if it fails to achieve a soft taper, that would negate any benefit from lower interest rates. Furthermore, since interest rate cuts have been expected for some time, the market has likely already priced them in.
The bottom line is that “Financial advisers shouldn't try to time the markets with points,” said Swedroe, the author of 18 books on investing. “You have to have an allocation to private equity if you want an allocation to private equity for any reason. It should be a long-term allocation and you shouldn't be trying to get in or out because chances are you're going to get it wrong.”