Bain: PE Investors Should ‘Temper’ Their Expectations

A maturing industry combined with possible recession could lead to a convergence of private equity and public market returns, according to Bain & Company.

Consistently high returns are fueling allocations to private equity (PE)—but with a possible downturn looming, funds will have to change to remain top performers, Bain & Company has argued.

In 2015, the private equity industry raised $527 billion in capital, with dry powder levels growing to a record $1.3 trillion, according to the consulting firm. But the sheer volume of capital has led to increasing valuations, making it more difficult for general partners (GPs) to secure assets at an attractive price.

Bain said the current fundraising conditions were driven by recent attractive returns, as well as a mass of fund exits, as investors sought to reinvest in the asset class.

Buyout-backed exits in 2015 totaled $422 billion, slightly below 2014’s record high of $456 billion. But with investment activity slowing—buyouts from 2011 to 2015 reached just $1.2 billion, compared to $1.8 billion from 2006 to 2010—Bain said exit levels are likely to diminish in the near future.

“As the slower pace of investments feeds through to fewer exits and smaller cash distributions flowing back to LPs [limited partners], the PE industry should settle into a more sedate new normal next year and beyond,” the firm argued.

This “new normal,” coupled with risks of recession and downward revaluations from current premiums, could lead to a convergence between private equity and public market returns, Bain said. Already, State Street’s global index of private equity funds has recorded the asset class’s first losing quarter since 2012.

“As healthy as PE returns were over the past three years, those vulnerabilities and the simple fact that the PE industry has matured should temper investors’ expectations that returns will remain as strong as they have been,” the consultant said.

According to Bain, GPs will need to “demonstrate to LPs that they have a sharply honed and differentiated strategy for achieving superior performance.”

The most successful firms will focus on their strengths, the firm said, zeroing in on their “investment sweet spots” rather than going after a broad range of deal types. High performing GPs will also identify sources of long-term sustainable growth and develop consistent and repeatable value-creation approaches.

Related: Private Equity Returns Waver After Three Years of Gains & Valuations Fail to Deter Private Equity Investors

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