In our view, valuations appear reasonable and private equity remains a compelling way for insurers to gain exposure to alternatives.
After spending the past two months dissecting risk and opportunities in fixed income markets, it’s time to shed light on another asset class: private equity.
With a track record of attractive upside and low volatility, private equity has been a staple in the alternative buckets of insurers’ strategic asset allocations. As macroeconomic uncertainty continues to rattle risk markets, some investors are asking about private market valuations. Whereas public market valuations have declined significantly since the start of 2022, the private arena hasn’t meaningfully repriced.
In our view, there are several reasons for the valuation disconnect with public markets. Here’s why we think PE valuations are holding up:
- Strong earnings growth: Resilient corporate earnings are helping offset the drag on valuations from depressed public market comparables.
- Flight to quality: Current investor preference is for high-quality companies with stable earnings growth, which warrant higher prices.
- Favorable supply/demand dynamics: PE funds are sitting on large amounts of dry powder that they are incentivized to deploy, which helps support prices.
- Long-term focus: PE funds have long investment horizons and valuation methodologies that smooth price movements over time, both in up markets and in down.
- Conservative baseline valuations: General partners value their own holdings, and many start with conservative valuations that they adjust slowly over time, usually over the course of several quarters.
And if history is a guide, we believe investors are likely to look back at today as an attractive entry point for private equity allocations. As the chart below highlights, private equity has done well compared with public markets in periods of broader market volatility.
Source: Cambridge Associates. Private Equity is represented by a horizon calculation based on data compiled from 1,387 US private equity funds, including fully liquidated partnerships, formed between 1986 and 2021. See Disclosures for the methodology for Cambridge Associates Modified Public Market Equivalent (mPME).
Private equity’s secondary market offers key advantages
For investors seeking access to private equity, the secondary market may be an attractive alternative to primary PE strategies. When a limited partner wants to make an early exit, they can sell their interest in a fund to other investors. This gives the primary investor a liquidity opportunity, and it gives secondary PE investors a compelling way to gain the upside potential of private equity with potentially lower risk.
Secondary PE managers often buy in after a majority of a fund’s assets are already invested in businesses, which means they can better navigate changes in valuations. In addition, primary investors typically sell their ownership interests at a discount to the fund’s potential long-term value, enticing secondary buyers to acquire their fund interests. When investors buy at a discount, they mitigate some of the downside risks of investing.
Private equity remains a staple of many insurance investment portfolios for good reason. We believe rational factors are guiding current valuations, and investors who take a long-term view stand to be rewarded.