Given that private equity is often characterised as a sophisticated, high-risk/high-reward investment, it might be expected to perform poorly during a recession. However, the evidence of private equity’s performance during previous downturns indicates the opposite is true – and reflects the inherent characteristics of the asset class.
Why private equity could exceed expectations in a recession
The experience of past recessions augurs well
The scorecard for the world’s largest economies is not encouraging. The outlook for the US economy has deteriorated, according to a recent Federal Reserve survey.1 China is struggling in the face of cooling global growth.2 Germany has already slipped into recession after reporting a contraction for two consecutive quarters.3
So, with a global recession a distinct possibility, it’s clearly worth asking if investors in private equity should be worried. After all, the link between an economic downturn and a bear market in public equities is clearly established. Take the global financial crisis. On 9 October 2007, the Dow hit its pre-recession high, closing at 14,164.53. By 5 March 2009, it had dropped by more than 50%, to 6,594.44, as the economic tsunami generated by the collapse of Lehman Brothers in September 2008 swept around the globe.4 A similar pattern unfolded in 2020, with the Dow Jones losing over a third of its value between 12 February and 23 March as global activity froze in response to Covid-related lockdowns.
As Figure 1 shows, private equities also endure setbacks during economic downturns, but they are significantly less affected than their public counterparts. Other analysts have come to similar conclusions. A report by Neuberger Berman, published in December 2022, found that private equity historically experienced a less significant drawdown – and a quicker recovery – than public equities. The findings were based on an analysis of the major economic downturn of the early 2000s, the 2008–09 global financial crisis and the 2020 Covid-related market events.5
Figure 1: Public equities significantly underperform private equities during recessions
Inbuilt buoyancy aids
These findings shouldn’t be particularly surprising, given the relative illiquidity of private markets. While that may seem like a disadvantage, it can help insulate investors from panic selling. The professional managers of private assets are also focused on long-term objectives, rather than short-term volatility in public markets and economies.
Moreover, while economic turbulence is clearly a risk, and investments could come under pressure during such periods, the evidence also suggests that managers can capitalise on the declining valuations and distressed opportunities that often emerge during economic downturns. Private equity, for example, generated some of its best-performing vintages during the dot-com crash of 2001 and the 2008–2009 global financial crisis, according to PitchBook data. These vintages produced above-average earnings for investors, with 2.11 times and 1.51 times TVPI (total value to paid-in, or the investment multiple), respectively, calculated seven years into the lifecycle of the fund, according to the private-equity business Moonfare.6
Private equity’s hands-on approach to managing the companies within a portfolio can also help. Managers can help ‘a business pivot during a downturn’, says the private-markets business New World Advisers.6 It explains that managers have ‘historically offered advice and resources to help guide a company through any strategic shifts, while also using their networks to assist in renegotiating loan terms or other liabilities to alleviate financing concerns’.
Well placed to ride out the storm
It would be dangerous to conclude that private equity will always perform well in a downturn, or that private equities or other private assets should be considered ‘less risky’ than public markets. However, it does appear that private equity has inherent attributes – including illiquidity, a long-term focus and an active approach – that help it weather economic storms relatively well.
1 https://www.reuters.com/markets/us/us-economy-little-changed-recent-weeks-outlook-deteriorated-fed-survey-2023-05-31/
2 https://edition.cnn.com/2023/05/09/economy/china-trade-april-hnk-intl/index.html
3 https://www.bbc.com/news/business-65707206
4 https://www.thebalancemoney.com/stock-market-crash-of-2008-3305535
5 https://www.nb.com/en/global/insights/the-historical-impact-of-economic-downturns-on-private-equity
6 https://www.moonfare.com/blog/private-equity-strength-recession
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