The turbulent events of 2023 have faded in the rear view mirror. Year-end results shrugged off banking failures, bond market gyrations, and higher-for-longer interest rate predictions, giving way to speculation about how central banks would begin to cut rates in the context of falling inflation. Exits, add-ons, and fundraising slowed with interest rates still elevated.
Geoff Cook (pictured), chair of Mourant Consulting at Mourant, a law firm-led professional services business, revisits the firm’s focus on private capital and refreshes its market commentary to reflect the sector’s prospects in the second half of 2024 and beyond.
The challenges that lie ahead
The cost of borrowing remains high, and the first half of 2024 presented challenges. However, the outlook is gradually improving. According to Bain & Company, private equity activity has stabilised, with deal making showing signs of recovery despite remaining below pre-2021 levels.
Still, despite the recent roiling in listed markets, disturbed by the uncertain prospects of recession in the US, alternative investments will continue to offer a relative safe harbour as a diversification strategy for public market investors. The industry is also likely to benefit from recycled capital as exits gradually improve, bolstering fundraising efforts and promoting a more favourable environment for new investments.
As the year progresses, the prospect of lower interest rates in the second half and the drive for liquidity by investors are expected to make some inroads into unwinding the exit pipeline and potentially easing fundraising conditions.
With central bank interest rates in the UK and US stubbornly north of 5%, attention will turn to the iconic ‘Jackson Hole’ gathering of the world’s central bankers on August 22nd. The conference will focus on “Reassessing the Effectiveness and Transmission of Monetary Policy,” a seemingly dry technical subject with enormous real-world consequences.
There will be massive interest in the speech to be delivered by Chair Powell of the Federal Reserve as observers search for clues as to ‘where next’, with benchmark interest rates currently sitting at a two-decade high. Market commentators’ consensus views anticipate a downward path in interest rates beginning in September.
Economic Landscape and Central Bank Policies
The anticipation of lower borrowing costs is a crucial factor driving improvement in the outlook for private capital. Lower interest rates would reduce the cost of debt financing, making leveraged buyouts more attractive and facilitating exits that have been stalled due to high financing costs. This environment will likely lead to an increase in deal activity and provide a much-needed boost to recycling capital from the exit pipeline as it begins to unblock.
Fundraising and Capital Deployment
Fundraising in the private equity sector faced headwinds in 2023, which continued in the first half of 2024. However, as confidence returns, LPs gradually increase their private equity allocations. The focus is on well-established funds with solid track records as investors seek stability and reliable returns in an uncertain market. In other corners of the industry, continuation funds and co-investment are facilitating longer hold periods for portfolio companies in the hope that valuations will firm as 2025 appears.
A notable trend we identified back in 2023 is the growing interest in sector-specific funds. Healthcare, technology, and sustainable investments attract investors looking for long-term growth. These sectors are seen as resilient and capable of delivering superior returns, even in challenging economic conditions, as artificial intelligence combines with data analytics to accelerate progress in patient care and diagnostics.
Innovation and Value Creation
The need for innovative value-creation strategies is more critical than ever. Private equity firms increasingly deploy technology and digital transformation to enhance portfolio company performance.
Successful firms can integrate advanced analytics, artificial intelligence, and automation into their operations to drive efficiency and growth. In the US, according to Deloitte, investment in energy-efficient technologies is reducing healthcare companies’ environmental impact and providing cost savings.
Environmental, social, and governance (ESG) considerations are becoming essential components of value creation. Investors emphasise sustainability more, and firms demonstrating strong ESG credentials are more likely to attract capital. This shift drives private equity firms to adopt more sustainable practices and invest in companies that contribute positively to societal and environmental outcomes.
Regulatory Environment and Market Trends
The regulatory landscape for private equity is evolving. In 2024, regulators focused more on increasing transparency and accountability within the industry. Following an AIFMD review, enhanced reporting requirements and stricter compliance standards are likely to be implemented in the EU to protect investors and ensure fair market practices. Sustainability regulation has also seen further disclosure requirements.
Regulatory changes across the US, UK, and EU reflect a global trend towards greater transparency, accountability, and investor protection in the private equity industry. Firms are now required to adopt more robust compliance and reporting practices, which, while challenging, aim to create a more stable and trustworthy investment environment.
Additionally, geopolitical developments and trade policies will impact market dynamics. The ongoing trade tensions and shifts in global economic alliances could shape cross-border investments and the overall flow of capital. Private equity firms must stay agile and adaptable to navigate these uncertainties and identify opportunities.
The Path Forward for Private Capital
The private equity sector has experienced a period of recalibration. The lessons learned from the disruptions of 2023 have emphasised the importance of agility and resilience. Firms that adapt to changing market conditions, embrace innovation, and align with investor expectations are more likely to prosper in the evolving landscape.
The first half of 2024 was challenging, but the outlook for private capital in the latter half of 2024 and going into 2025 is more positive. With the prospect of lower interest rates, improving fundraising conditions, and a focus on innovative value creation, the industry is moving into calmer waters. By staying informed and proactive, investors and firms can seize emerging opportunities and navigate the complexities of the modern economic environment.
Role of Small State International Financial Centres
Small State International Finance Centres (IFCs) continue to play a pivotal role in attracting a large share of private capital cross-border business due to implementing several strategic measures:
Firstly, they have focussed on enhancing their regulatory frameworks to ensure robust investor protection while maintaining flexibility to adapt to global standards.
Secondly, by offering streamlined processes for fund registration, they have become even more attractive to fund promoters.
Additionally, investing in technology to provide efficient digital services, including e-governance and cybersecurity, has built investor confidence.
Finally, promoting transparency and engaging in international cooperation to combat financial crimes will further enhance their reputation as reliable and secure investment hubs.
Key Takeaways and Future Outlook
1) Interest Rates and Economic Conditions: The potential for lower interest rates in the second half of 2024 is a critical factor that could drive renewed activity in the private equity market. Investors should monitor central bank policies closely as these will influence borrowing costs and deal feasibility.
2) Fundraising Trends: Moribund fundraising will improve as investor confidence seeps back. Sector-specific funds, particularly in healthcare, technology, and sustainability, will likely attract capital. Investors should consider diversifying their portfolios to include these high-growth sectors.
3) Innovation and ESG Integration: Integrating technology and ESG factors into value-creation strategies is essential. Firms that leverage advanced analytics and sustainable practices will be better positioned to deliver superior returns and attract capital.
4) Regulatory Developments: Regulators will focus on increased transparency and accountability. Firms should anticipate enhanced reporting requirements and ensure compliance with emerging standards to maintain investor trust and market integrity.
5) Geopolitical and Market Trends: Geopolitical developments and global trade policies will continue to impact private equity. Firms must stay agile and adaptable, keen on emerging markets and potential cross-border investment opportunities.
By understanding these key trends and preparing for the evolving market conditions, private equity firms and investors can position themselves for success by improving market sentiment in 2024 and beyond. The journey ahead may be complex, but the private capital industry can navigate towards a promising future with strategic planning and informed decision-making.
By Geoff Cook, chair of Mourant Consulting at Mourant