Are the heydays of Private Equity over?

I personally think there will be a market consolidation as there are a billion funds which benefitted from multiple expansion but are simply not good investors. Yet there will remain some strong funds, imo particularly those strong in actual value generation / operational improvement.

Great post above and agree that there will always be a place for top quartile funds and buyout in a diversified LP portfolio. Alternative investing will only continue to grow as an asset class overall as it becomes more mature and accessible (and in doing so lower fees). Strong funds will have a chance to differentiate themselves over the next decade and many funds founded in the late 90’s and early 2000’s will likely struggle with leadership transitions. You are already seeing a heavy movement down market to find less competitive or proprietary deal flow. Every founder I speak with that is $5M-$10M of EBITDA in an interesting sector is constantly being courted by PE. JAMBOs will likely struggle the most unless truly thematic or heavy downstream buy and build as the mega caps will always be able to find market dislocations via public equities/debt such as we are seeing now with more take private activity and carve-outs (granted, with their typical 2x baseline gross returns versus say 3x).

Interesting comment about JAMBOs. I was thinking that large cap would struggle a bit more given that there are so many funds that can do large deals these days, and only so many deals of those size. But I guess the headwinds will be felt in different ways across the industry. I work at an MM/UMM and I think we feel well positioned for the future, but idk for sure of course

Radical idea here, just spitballing w a macro prediction. I actually am extremely bullish on private equity. One of the main reasons why PE took off after the GFC is because of the growing regulatory burden of banks. If you think about it, a private equity firm is able to take more tail risk on credit which a bank, post GFC with rising capital requirements, can’t. Unstable banks create problems as we have seen during the SVB and First Republic bank runs, and the failure of CS. The failure of banks to hedge risk for rates volatility will create more policy which restricts risky credit opportunity for banks. Just like the GFC, and the bank runs we have seen so far in 2023, this creates an endless cycle that restricts the crediting ability of banks more and more after each mistake.

In the Long run, it is possible that we are adapting to a banking system that takes very little lending risk—because private equity and other non bank finance is able to fill this role. All of the risky lending that banks previously did can be done from PE and other non bank finance without being funded by liquid demand deposits—which run the risk of a bank run. As banks become more and more regulated there will be a structural demand for the lending capabilities of PE.

There are many caveats to this thesis which I could see preventing a clear structural need for PE in the manner which I describe. I will list them in separate points below:

1.) This argument assumes private equity always adds more value than bank creditors in high rate environments. Private equity has been the largest beneficiary of the low rate, growing money supply macro regime we have had for the last decade. At the end of the day, it was very easy for these funds to invest over the past decade and many took on risky investments that worked out well because of the current smooth macro outlook. What will happen when PE deals with higher rate environments? Will their higher tail risk and greater DD than banks still yield high returns? For the foreseeable future, the FED will not be able to park rates back down like they did after GFC. So far, there answer is no, PE isn’t doing great in a high rate environment. Growth has been slowing pretty fast in the industry over the past 2 years, and the returns of many of WSO’s great MFs, risk adjusted, hasn’t been great. If private equity cannot thrive in a high rate environment, then it cannot be a structural answer to the long run regulatory tendency to reduce the risk taking lending capabilities of banks.

2.) what do we do about money supply in this PE-lending future? PE doesn’t create money when it loans. A bank does. In this world, people would get yield on money markets on short terms at high rates from the Feds. Likely because of a higher need to inject money to manage money supply, bc macro 101 says that the multiplier effect of lending is no longer in effect. Curious how this change would affect the macro regime, and PE performance, as a whole. What I proposed is a possible way the Feds respond to deal w money supply, but there are other ways as well.

Don’t confuse easy with rewarding. Low rates made taking on subpar deals attractive and made it EASY to make profit.  It’s back to reality, at least for now.  You have to roll up your sleeves, pick good investments, and actually manage them because capital isn’t  free anymore for the ridiculously stupid risks private equity takes. People in PE need to ask themselves:  Are you there for the paychecks and what you think is prestige? Or do you actually want to do the job,