Private equity 2024 outlook

Last year turned out to be one that many Wall Street experts got very wrong. In the end, a global recession never materialized, inflation normalized and liquid risk assets repriced meaningfully to the upside. In 2023, the MSCI World TR Index appreciated 24%, the S&P 500 TR Index climbed 26% and the Nasdaq Composite TR Index advanced almost 45%.¹ While liquid markets rallied, persistent recession fears and elevated interest rates created headwinds for private equity markets. Deal volume and exit activity were down significantly, resulting in a muted fundraising environment.  Today, market sentiment has shifted away from a recession base case and toward peak Federal Reserve (Fed) tightening with expectations for rate normalization in 2024. We believe private equity (PE) is poised to recover across deal volume, exits, and potentially fundraising, although fundraising will likely remain challenged, in our view. 

In addition, artificial intelligence (AI) helped drive liquid markets to near all-time highs in 2023. Looking ahead, we believe the focus on AI will grow within PE portfolios in order to drive productivity and long-term value creation. We expect PE managers will also increasingly focus on sustainable investing, given the opportunity set the multi-trillion dollar annual spend on the energy transition to meet carbon emission goals has created. We also anticipate continued expansion of PE into wealth portfolios to better optimize return and diversification outcomes.

Green shoots for PE activity

In an effort to address inflationary spikes, central banks raised interest rates significantly starting in 2022, leading to materially higher debt financing costs and weighing on PE deal economics. This dynamic, coupled with recession fears, caused a dramatic decline in PE deal activity. Take-private transactions fell 40% and global deal volume declined 25% in 2023.² Further, the 2022 correction in equity markets slowed initial public offering (IPO) markets the following year, causing PE exit activity to fall dramatically.  As a result, lower distributions back to limited partners (LPs) led to a challenged fundraising environment. The value of PE monetization as a percentage of capital deployment remained below 40% in 2023 for the third consecutive year – a level not seen since 2009.³

Dynamics have since shifted, and we expect green shoots to appear.

While interest rates remain elevated, they have fallen significantly from the October peak with market expectations for multiple Fed rate cuts in 2024. Five-year US government Treasury notes, for example, declined from approximately 5% in October 2023 to 3.8% by year end.⁴ Further, the leveraged loan market continues to normalize, creating more favorable financing options for PE deals.⁵ Additionally, IPO markets are expected to thaw out this year given strong equity market performance in 2023, including robust gains for IPOs as measured by the Renaissance IPO Index, which rose more than 50%.⁶ This will likely help drive PE exits to allow capital to recycle back into the system. Also notable is the robust fundraising in the PE secondaries market, which will also provide expanded liquidity solutions. Buyer and seller expectations around pricing created wide bid-ask spreads that slowed deal activity after markets repriced in 2022. The gap has since narrowed, which we believe sets the stage for more deal activity in 2024.

AI going mainstream

The use cases for AI are vast, and the value creation potential across economies is significant.  The AI theme was a meaningful driver of stock market returns in 2023 and will continue to be a major theme for years to come, in our view. PE players have taken notice, and many are laser- focused on integrating AI across their portfolio companies and due diligence processes to drive greater operational efficiencies.

AI can be transformative across the PE ecosystem in a number of ways—through portfolio company value creation, deal sourcing, due diligence, monitoring and other operational activities. According to the EY CEO Outlook Pulse survey of 2023, 70% of CEOs around the world believe companies must move forward with AI to avoid falling behind the competition. McKinsey & Company identified 63 generative AI use cases across 16 business functions that could drive US$2.6 trillion to US$4.4 trillion of economic value annually.⁷ In a nutshell, it has become clear that AI has become a primary strategic focus for many businesses, and harnessing its value proposition can be a material competitive advantage.

Sustainable investing moves beyond a tipping point

Despite some political pushback in the United States, sustainable investing adoption continues. According to a Dechert LLP survey, 94% of PE firms surveyed globally have already implemented sustainable investing capabilities in their investment processes.⁸ In Europe, the adoption of Sustainable Finance Disclosure Regulation mandates that asset managers provide relevant sustainability disclosures to their investors, a step in the right direction to create reporting standardization and facilitate further adoption of sustainable investing. The Conference of the Parties 28 (“COP 28”),⁹ which took place in December 2023, marked what many are referring to as the “beginning of the end” for fossil fuel. The summit was a seminal event for energy transition, as 200 countries agreed to move away from fossil fuel to meet climate goals. COP 28 ended with a deep sense of urgency for all countries to deliver climate outcomes aligned to the Paris Agreement with credible action plans due by 2025. 

As a number of institutional investors pledged support for net zero and adopted internal sustainable investing policies to support fiduciary goals, general partners (GPs) have likewise been motivated to implement sustainable investing programs to align with their investors. For example, in late 2023, CalPERS introduced its Sustainable Investments 2030 Strategy that commits US $100 billion to reduce the carbon emissions of its investments by 50% by 2030 to support net zero goals.¹⁰ CalSTRS also committed to reducing carbon emissions in its portfolio by 50% by 2030, in addition to allocating 20% of its Public Equity portfolio to a low-carbon index and buying a minority stake in Al Gore’s climate-focused investing firm called Just Climate.¹¹

Overall, the energy transition to net zero is creating a meaningful investment opportunity set given trillions of dollars required to achieve climate goals. As a result, we expect environmental factors to be a key focus to drive top-line and/or cost-based value creation.

Private wealth and retail penetration

PE will continue to expand into the wealth and retail channel globally. The PE value proposition for retail is very similar to that for institutional investors: diversification, performance enhancement potential, and downside risk protection. Greater deployment of fund structures like interval funds in the US and European Long-Term Funds (ELTIFs) in Europe, technology platforms, and investor education to develop understanding of how best to incorporate PE strategies into portfolios and liquidity management will likely drive continued adoption in the wealth and retail segments.

Historically, equities and bonds have been diversifying to one another. For the 10-year period from 2012 to 2021, the correlation between global stocks and bonds averaged -0.01 with a maximum correlation of 0.29 in 2012.¹² As monetary policy has driven price action for both bonds and equities in similar ways, the correlations between the two have increased significantly—leading to reduced diversification benefits. Further, as companies are staying private longer, or foregoing public markets altogether given higher regulatory scrutiny and costs, the investment opportunity set in the private markets has expanded considerably. As a result, wealth and retail investors are looking to PE to optimize their portfolios and to enhance return and diversification outcomes.