Sunday, August 30, 2020

Private Equity: Asset Class of the Decade With Room to Grow

Perhaps no industry has benefited more from 'lower for longer' than PE. Near zero interest rates are ideal for LBOs. And institutional investors desperate for higher returns have turned to PE as this FT article points out, which in turn draws from this MSIM tome. 

Consider CalPers' required rate of return as representative of public pension funds (most of whom are similarly underfunded):

Year 30-Yr Tsys Yield Required Return
1981 15.0 6.5
1992 7.8 8.8
2021 1.2 7.0

Historically, PE has produced about 12% annual returns and outperformed US equities on average by 3% annually between 1980 and 2010, though returns have started to come down since 2006 as the industry has grown. Still, with US equities expected to generate 5%-6% annual returns over the 10 next years, PE looks very attractive by comparison. (Moreover, periodic and subjective marking of positions result in more smoothed returns than public equity. So, higher returns AND seemingly lower risk? Perfect!!)

The popularity of PE is evident in the industry's rapid growth. As McKinsey notes private markets AuM has grown by 170% and the number of funds has doubled in the last 10 years. And the SEC is now expanding retail investors' access to PE, potentially giving further boost to asset growth. All of which may pressure returns to the point PE sees the same return degradation as HFs. But as long as interest rates stay near zero it should all be fine for PE managers.  

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