Underperformance from Private Equity Funds Expected, Relative to Public Equities, Resulting in Flattish Absolute Returns: Pitchbook

Without offsetting topline growth or debt reduction, management will need to increase efficiency and reduce investment “to retain earnings power and, even then, may face lower valuation multiples,” the team at Pitchbook noted in a comprehensive market update.

Hence, Pitchbook now expects further underperformance “from PE funds relative to public equities, and as a result, another year of flattish absolute returns.”

When dissecting performance on a one-year rolling IRR basis (as of Q4 2022), Pitchbook finds that middle-market funds “are outperforming.” Funds in the $250 million “to $500 million range posted the top performance, up 8.2%; followed by funds in the $500 million to $1 billion range, up 2.8%; and funds in under the $250 million range, up 2.4%.”

Large funds “holding over $1 billion—the bulk of the market by capital raised—were down 1.8%, dragging the overall PE segment to a total of down 1.2% on the one-year rolling IRR metric.”

On a geographic basis, North American funds reportedly “fared relatively better, down 0.4% in Q4 2022 on a one-year rolling IRR basis. Europe-based funds were slightly worse, down 0.6%, while PE funds in the rest-of-world category struggled, down 8.2%.”

Kaidi Gao, Associate Analyst, Venture Capital, noted that “for VC funds, Q4 2022 registered a sixth consecutive quarter of decline in the rolling one-year horizon IRR, and a second successive quarter where the IRR figure landed in the negative territory.”

As mentioned in the extensive report from Pitchbook, this sharp slide “stands in stark contrast to the 2021 private market exuberance and IPO frenzy, and the downward trajectory is likely to continue through the next few quarters.”

Macroeconomic headwinds and public market volatility “have compressed price-sales ratios for public tech companies, resulting in a challenging outlook for startups desiring to IPO but holding high valuations from rounds raised in 2021.”

Companies are staying private “to wait out the market downturn by delaying an exit, but additional holding times pressure fund IRRs.”

Pitchbook also mentioned that smaller venture funds “have outperformed their larger counterparts during recent periods.”

As explained in the report, a reason for this outperformance is “that those funds have focused on the earlier stages of the venture lifecycle, where valuations have held up relatively well throughout the slowdown.”

In addition, GPs with smaller fund sizes “might have been unwilling to mark down their portfolio to match the fair market value—either in hopes of waiting for the market downturn to pass and valuations to rebound, or out of concern that they lack strong performance to present to LPs during fundraising conversations.”

Anikka Villegas , Analyst, Fund Strategies & Sustainable Investing, shared that “despite several consecutive quarters of declining rolling one-year IRRs, real estate returns remained above COVID19-induced lows at the close of 2022, which cannot be said for most other asset classes.”

At 7.7%, the one-year numbers reportedly “were not lofty compared with historical norms, but there were a few bright spots for performance.”

As noted in the detailed report from Pitchbook analysts, distressed funds “pulled ahead with respect to one-year returns, with a 10.5% IRR per our Real Estate Benchmarks (as of Q4 2022), as the effects of counter-inflationary monetary policy and market corrections in some areas had presented more fruitful opportunities for the strategy.”

Value-add funds were “a close second, at 10.0%, while opportunistic fund returns came in at 7.8%.” This difference may “be attributable to the compounding factors faced by opportunistic investors—particularly those nearing the end of their fund lives, who had to make exits in an unfavorable environment after unexpectedly overspending on large construction and renovation projects due to inflation.”

As the scope of projects involved “in value-add strategies are generally smaller, these downward forces were likely felt less intensely.”

As stated in the report, real estate’s Q4 2022 quarterly returns and Q1 2023 preliminary numbers “were low, but positive, at 0.4% and 0.7%, respectively.”

The report added:

“While this might suggest the beginning of a performance recovery after Q3’s -0.9%, they are still in line with the nadirs of the past decade. Among the different real estate strategies, quarterly returns also indicate a reversal of the trends visible in the one-year numbers. Core and core plus funds’ quarterly returns have been crawling up from Q3 2022’s -4.3%, reaching -2.5% in Q4 2022 and a preliminary 7.9% return in Q1 2023.”

The report from Pitchbook continued:

“With core and core plus’ rolling one-year IRR for Q4 2022 being the lowest of all strategy categories at -5.4%, this upward trajectory was likely welcome news to those invested in the two strategies. For value-add vehicles, quarterly returns have been trending downward for the past four quarters and in the negatives for the past two, reflecting lingering impacts from macroeconomic and market shifts.”



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