Why is Private Equity the asset class of choice in a volatile economy?

Private Equity’s long-term investment horizon is even more appealing to investors in a global financial market characterised by short-term change. Mourant Partner Darren Bacon explores the benefits of PE’s long-term perspective and outlines why the climate is right for it to maintain its position as the go-to asset class of choice for many investors.

Recent times have been good for Private Equity (PE). The stability offered by the asset class was attractive in the turbulent 2010s, meaning that fundraising wasn’t an issue. Private investors are sitting on a record $1.5 trillion in cash, according to new data from Preqin. That is the highest on record and more than double what it was five years ago. Analysts say investors are flooding to private equity thanks to low interest rates, hedge fund underperformance, and lower than expected returns from public markets. The flush of cash means more competition for the same deals, however, pushing up valuations. Some analysts think returns will disappoint.

In Guernsey, the total flow of investments from UK investors facilitated by Guernsey funds has roughly doubled since 2013. The most recent statistics available from Guernsey Finance show the island has more than £120bn of regulated PE funds domiciled here. In the funds space overall, Mourant has continued to drive a strong PE practice. Its commercial judgment and technical expertise has led to us having the second-greatest market share locally by number of funds, including leading PE funds.

The 2010s may have ended, but the short-term market volatility that characterised the decade’s latter half certainly hasn’t. Huge government borrowing and spending worldwide to combat the effects of the coronavirus pandemic, together with the sharp market shock created by the initial outbreak, have resulted in a unique landscape. But this is arguably to the benefit of PE investors who will see their assets grow from the sector's position which seems destined to thrive.

In it for the long haul

PE’s long-term investment horizon has always been appealing to investment managers looking for steady returns. That allure is arguably greater now, with low interest rates and volatile markets combining to make other investments riskier from the outset.

Similarly, a shock like COVID-19 can be devastating to investments reliant on short-term returns. The contrasting buy-and-hold model favoured by PE – which is predicated on generating wealth over the long haul – seems a sound strategy in this economic climate.

Stable conditions of course don’t guarantee good returns, but they are conducive to a steadier yield, or ultimately a larger pay out. There is a clear alignment with Guernsey as a preferred location for fund domiciling. The Island’s stable political system, flexibility to adapt and pragmatic regulatory regime have all played their part in confirming Guernsey's continued position as an established, secure, safe and robust jurisdiction and our clients around the world continue to recognise this.

A long-term investment horizon is also inherently aligned with environmental, social and governance (ESG) factors, which are rapidly climbing up the corporate agenda together with their green bedfellow - sustainability.

In the funds space, managers are increasingly being asked to report on their ESG performance. The longer your investment horizon is, and the longer you’re posting returns, the more data you’re going to have and the more accurate your reporting can be. The tide has turned on ESG and sustainability, and mandatory disclosures will be introduced sooner rather than later; PE’s advantage here is that it has always been geared to the long term, giving it the platform to succeed in a greener future.

A positive outlook for PE

The increased focus on ESG and sustainability is the result of shifting expectations, partly provoked by people looking for certainty amidst the short-term volatility.

In the UK, the vaccination programme has people dreaming of a return to normality, but we’re a long way from that in economic terms. Brexit may have been agreed but it continues to challenge for the headlines and with trade deals still to be agreed – along with wrangling over vaccines - certainty remains quite far away.

A new government in the United States is settling in but its attitude towards the rest of the world, and most importantly China, is yet to be fully revealed. Continuing protests in Hong Kong and Myanmar give a glimpse of political unrest in Asia, and the developing world continues to feel the impact of COVID-19.

There are certainly global challenges, but for PE these (hopefully) short-term uncertainties increase the attractiveness of the asset-class’ long-term view.

The economic situation has caused depressed valuations across the board, which is a double-edged sword for PE. On the one hand, it’s a good time to have capital to invest, and PE has plenty of dry powder. But it does increase the need to find quality assets to invest in; cheap isn’t necessarily good.

Overall the conditions are ripe for PE to continue to thrive, and this is backed up by EY’s finding that PE historically performs well after a recession.

The global landscape seems to be lending itself to PE reinforcing its position as the asset of choice, and the allocation patterns of the increased levels of private capital suggest this is the case. If this trend continues then Guernsey looks set to benefit, as its stability is a natural ally of PE.

Mourant’s Guernsey heritage is a vital part of why the world’s leading PE houses choose us as their provider of a full lifecycle PE fund offering. Get in touch to learn about our capability from fund formation, through investment, to exits and beyond.