A Second Boom in Private Equity?

It’s been an amazing run for private equity. As measured by the performance of publicly traded private equity companies, the value of private equity investments is up anywhere from 61% to 163% from the end of 2015 through March 12, 2020, returns most any investor would take even if over part of the years private equity was not the absolute winner among all asset classes.

Lower rates

The boom in private equity has turned into a thump, which has some wondering whether a rebirth is around the corner. What could be the trigger for a rebirth? Perhaps even lower rates than what the world recently saw may do the trick.

Just in March, as of writing, 14 central banks had lowered rates, including Argentina (-200 basis points (bp)), Canada (-50 bp), Moldova (-100 bp), Jordan (-50 bp), Kuwait (-25 bp), Qatar (-75 bp), Macau (-50 bp), Hong Kong (-50 bp), United Arab Emirates (-50 bp), Bahrain (-50 bp), Saudi Arabia (-50 bp), the United States (-50 bp), Malaysia (-25 bp), and Australia (-25 bp).

Recent moves to lower rates in March come on the heels of action earlier in the year. In January and February, 21 other central banks reduced rates, while only two central banks raised rates. Unless inflation picks up rates are heading lower.

Everyone deserves a second time around

With lower rates, the obvious question is – What do they mean for private equity activity? The answer is probably – a lot. Private equity firms often borrow money to finance deals, such as in mergers and acquisition, leveraged buyouts, and late-stage venture capital. When money is cheap, private equity deals look more attractive to investors and private equity money managers.

How much of a difference could lower rates across the globe make? Well, potentially quite a lot as long as private equity managers feel they can find good deals.

Consider, for instance, a potential leveraged buyout where the potential internal rate of return (IRR) is 11%. Suppose because of central bank action, the private equity firm thinks it can lower its interest costs from 4% to 2.5%. That 1.5% difference could push the IRR up from the 11% to perhaps 17% or 18% – potentially making the private equity investment potentially too profitable to pass up.

Conclusion

Overall, the shift to even lower interest rates than what the world has already seen suggests another round of strong private equity activity may be on the docket for the latter half of 2020 and going into 2021 and 2022. It’s a good time to looking for private equity investment deals.