Patrick Reid, alternatives specialist at Morgan Stanley Investment Management, said that manager selection will continue to be key for private equity (PE).
“Leverage’s contribution comprised roughly one-quarter of total Multiple on Invested Capital (MOIC), only slightly behind multiple expansion,” Mr Reid said.
“Higher borrowing costs and less buoyant IPO and strategic buyer demand are hindering multiples. Monetary tightening, fiscal retrenchment and supply-side disruptions are shrinking global demand.
“The economic slowdown, coupled with higher inflation and rising interest rates, has pushed global equity markets into bear market territory. Rising interest rates may trigger reduced leverage and lower multiple expansion, limiting the contribution to performance from these key return levers.”
He added that in an environment of rising interest rates and multiple expansions is unlikely to drive returns in the same way it has over the last two decades.
“Buy-and-build strategies are key to unlocking stronger revenue growth and maximising operational efficiencies, as they help to grow scale and capture synergies. This investment approach is repeatable and often enables add-on acquisitions at below headline valuation multiples,” Mr Reid said.
“We are staying the course as PE absorbs market dislocations and capitalises on interesting entry points. PE is showing the most growth potential among private asset classes and is on track to account for nearly 70 per cent of alternatives AUM by 2025, according to Preqin.
“We continue to build on PE’s exceptionally robust performance over the past decade. We focus on profitability-enhancing operational improvements and strategies that capture synergies best placed to generate alpha.
“General partners (GPs) must implement best-in-class operations and capture synergies and scale through strategies such as buy-and-build.”
According to Morgan Stanley, there is currently a record level of funds available, with dry powder at $3.6 trillion, which Mr Reid said should sustain high transaction volumes.
“Amid continued competition for quality assets, deal origination at attractive value-at-entry levels is not a given, and GPs must remain selective and disciplined to create value,” he said.
“Earnings become increasingly important as a source of value creation due to multiple compression and rising debt costs. Investors continue to increase their allocations to alternatives to meet their long-term investment objectives.
“Partnering with founders in the midmarket, particularly those seeking support from financial investors for the first time, and reducing operational vulnerabilities may make businesses less sensitive to economic headwinds.”
