2. Leverage Levels Are not as High as They Used to Be
Higher borrowing costs set a higher bar for returns, but how much one borrows helps determine the height of the bar. Overall, private equity managers are relying less on leverage than in the past. In 2013, debt as a percentage of total capital structures reached about 60%. Today, by comparison, that percentage is closer to 35%.
In higher-rate environments, it is critical that managers have the experience and the tools to manage the cost of capital. Knowing when to dial down borrowing and by how much based on the interest rate environment, refinancing debt when rates are lower, and ensuring that portfolio companies have the right capital structures are essential skills for successful private equity managers. We have found that a scaled presence and strong relationships in the capital markets can also help secure financing on attractive terms, particularly when capital is scarce.
3. Private Equity Managers Can Take Advantage of Inflationary Shocks
When interest rates go up, multiples tend to come down, and good assets tend to become available at a discount. Private equity has historically experienced strong relative performance when public equities falter. Exhibit 2 shows that the worse public markets performed (represented by the S&P total return ranges shown in the x-axis), the greater private equity outperformed (represented by the excess return of private equity versus the S&P 500 shown in the y-axis). The chart also shows our macro team’s view that we have been in a long period of public equity outperformance, but potentially headed toward more modest performance given slower economic growth in many large economies and higher-for-longer interest rates.
EXHIBIT 2: Relative Private Equity Performance in Past Periods of Complexity