The COVID-19 pandemic brought unprecedented disruption to the world in 2020, and these changes also created a wild year in the global private equity sphere. Private equity deal volume fell by 20% during the first half of 2020 compared to the previous year. It rebounded in the second half of the year, though, creating the highest level of deals since 2007.
These startling ups and downs all happened as the pandemic was wreaking havoc on the economy. Private equity sponsors, however, were more creative and flexible than ever during this volatile time. They also provided lifesaving injections of liquidity into the industries most severely affected by the pandemic, such as hospitality, retail, travel, and energy.
The lingering effects of the COVID-19 pandemic are continuing to shape the private equity sphere, and they have had a significant influence on some of the most popular private equity trends emerging in 2021. This guide looks at the factors shaping private equity trends right now, and it provides a snapshot of the most pervasive trends investors will see in 2021 and beyond.
The Factors Shaping Private Equity Trends in 2021
A variety of forces in the marketplace are shaping current private equity trends. Investors make decisions in response to changes in the investment sphere and the world in general. Here are the five most significant factors affecting private equity trends right now.
Significant Market Tailwinds
The momentum created during the second half of 2020 has continued through the first half of 2021. The deal volume during this period increased by 21.9% compared to the same period the previous year.
Historically Low Interest Rates
The zero-interest-rate policy created by the Federal Reserve, coupled with the Fed’s corporate bond program, allowed private equity funds to easily access cheap credit. The central bank is expected to stay the course, and historically low interest rates are likely to be affecting the private equity sphere through 2023.
Record Fundraising
Fundraising is at an all-time high, and at the time of writing, U.S. private equity dry powder – or unspent capital that’s waiting to be invested – is worth over $150 billion. Private equity funds are also sitting on about $1.7 trillion in dry powder, indicating that the capital supply is plentiful and that record fundraising levels should continue. Experienced private equity professionals are also setting up new funds, creating increased levels of deployable capital.
Tax Law Uncertainty
Proposed changes to the capital gains tax rate also affect private equity deals, because investors want to lock in gains before any increase. This uncertainty is giving rise to more deals than usual.
Increased Competition
Competition for private equity deals is increasing, which is putting more pressure on returns. Private equity firms must become more diversified if they want to effectively mitigate the risk of low returns.
Note that although COVID-19 is not listed as a factor, it has influenced many of these elements. It has also ushered in behavioral and business changes that affect both current and emerging private equity trends.
The Biggest Private Equity Trends for 2021
You now understand the factors shaping the private equity landscape, but what’s actually happening? What changes are investors making? What types of investments are gaining the most interest? Here is a look at nine of the most significant private equity trends right now.
1. Asset Diversification
Private equity firms have been transforming into multi-asset class managers for the last decade. They have expanded their offerings to include private debt, real estate, infrastructure, and more so they can offer more options to limited partners who want to allocate larger amounts of capital.
Diversification is becoming even more intense, as investors and firms try to mitigate the risk of low returns as much as possible. The diversification trend is likely to continue through increased attention to asset classes such as credit, growth, infrastructure, and specialty funds.
2. Increased Attention on Socially Responsible Investing
Environmental, social, and governance (ESG) investing will become even more popular as investors experience a heightened interest in sustainability due to the threat of climate change and cultural shifts toward accountability. Private equity firms see ESG investing as a value driver, and they are likely to implement more deals in this category throughout the upcoming years.
ESG investments performed just as well as mainstream funds during the pandemic, but investors are drawn to these investments because they are more than a moneymaker. They also help solve social problems, and they are linked to resilient businesses that are less likely to be hurt by changes in social expectations or regulations.
3. Greater Emphasis on Value Creation
Private equity firms are going to be increasingly focused on identifying and claiming value opportunities. The pandemic emphasized the importance of agility and resilience — businesses with flexible processes and resilient capital structures were more likely to grow and withstand vulnerabilities.
Investors are focusing on businesses that fit this model because they want to increase alpha opportunities. They want investments that outperform popular benchmarks.
4. More Interest in Special Purpose Acquisition Companies
The year 2020 was a record-breaker for special purpose acquisition companies (SPACs). They raised a total of $83.4 billion across 248 initial public offerings (IPOs) — over six times the previous record of $13.6 billion in 59 IPOs, set in 2019.
SPACs accounted for nearly half of all 2020 IPO volume. Their previous peak was 14% of IPO volume in 2007. Many large private equity firms have been sponsoring SPACS, and they are seen as an effective way to diversify investment strategies and monetize investments in portfolio companies. SPACs will continue their rise in popularity in the upcoming years as private equity firms sponsor an increasing number of SPAC vehicles and sellers explore different paths to liquidity.
5. The Return of PIPES
The financial crisis that ran from 2007 to 2009 created increased interest in private investment in public equity (PIPE), and the financial crisis created by the COVID-19 pandemic has brought focus back to PIPEs.
There were about 120 PIPE transactions in 2020 that involved companies listed on the New York Stock Exchange (NYSE) and the Nasdaq, and they had a total value of $36 billion. Interest in PIPEs will continue as long as investors feel any sense of economic uncertainty.
6. Increased Interest in the Tech Space
Investments in the tech space led the private equity rebound at the end of 2020. These investments have accounted for between a quarter and a third of all private equity investments for the last few years, but now they represent approximately 40% of the total value of all private equity deals.
Tech sphere investment interest is likely to continue through the end of 2021 and beyond because of pandemic-driven changes in work and socializing. Other industries that have benefited from the new environment created by the COVID-19 pandemic also expect to retain their momentum. This includes the education, logistics, and health care industries.
7. More Recapitalization Opportunities
The COVID-19 pandemic hurt more industries than it helped, and many businesses were forced to find ways to repair their capital structure as stimulus programs came to an end and banks started restricting lending. Analysts expect 2021 to be one of the best investing periods of this generation because of these recapitalization opportunities.
8. Longer Due Diligence Processes
Investment is up, but investors are not acting quickly. They are taking longer to research their targets throughout the private equity sphere and are requiring more data, analytics, and greater target transparency when they perform due diligence.
Pandemic travel restrictions, in particular, prevented investors from being able to do intensive in-person analysis. Target management teams, by extension, needed to provide more compelling pitches on paper, and they took more time to explain their equity stories and provide sell-side diligence reports. Both investors and asset owners are likely to engage in a longer due diligence process, with the involvement of more sell-side advisors for the foreseeable future.
9. Increased Exits
Exits typically take five and seven years, and during the pandemic, many investors delayed their exits amid lower internal rates of return. This year is expected to be a record-setting year for exits, though, because IPOs and trade sales are likely to increase as vaccine rates grow and travel restrictions are lifted. Steady valuations also support seller pricing, making exits even more likely.
General partners will monetize investments by getting involved with IPO listings, trade sales, and secondary transactions. The low-rate environment, along with concerns about the proposed capital gains tax hike, are also likely to increase exits.
Investors are paying close attention to the types of investments that have the most relevance and the highest returns, but they aren’t just looking at the numbers. They’re also thinking about the broader social and ethical implications of their decisions.
More diversification, a greater emphasis on value, and increased interest in socially responsible investing lead the private equity trends for 2021. As the other trends shift and change, these three elements are likely to stick around.
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