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Rethinking the re-up in private equity

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This is a sponsored article from Schroders Capital.

As we enter a new market paradigm, private equity investors should consider the replicability of past successes. Schroders Capital explores the most compelling opportunities in private equity currently.

Tim Boole, Head of Product Management Private Equity; and Co-head of Schroders Capital Structuring
Verity Howells, Investment Research Manager, Private Equity, Schroders Capital

Schroders’ 3D Reset framework, characterised by Demographic change, Decarbonisation, and Deglobalisation, is reshaping long-term growth and inflation dynamics globally, creating a new market paradigm that will affect the spectrum of private markets investments.

Although today’s inflation may abate, the 3D Reset is driving inflationary pressures in many Western economies, which will likely keep interest rates structurally higher. This environment challenges large private equity buyout strategies that depend on stimulative rates. In contrast, small-mid buyouts become more appealing as they are experiencing a more stable dry powder situation than large buyouts, resulting in less deal competition and lower entry multiples.

Investment opportunities in private equity in India and China

The 3D Reset will also create growth tailwinds in certain economies, particularly in Asia, driven by demographic advantages and growing disposable incomes, as opposed to the more export-orientated growth that was the primary driver in the past.

Considering these new market dynamics, investors should focus on opportunities that benefit from transformative trends, diversify private equity allocations, and concentrate on areas with healthy fundraising dynamics. Small-mid buyouts are expected to outperform large ones, and there are also promising prospects in India and China’s onshore RMB-dominated market.

The attractions of the small-mid private equity segment

Over the last decade, fundraising by large private equity funds has far outpaced deal flow, resulting in greater competition for deals and higher entry valuations. From 2010 to 2022, large private equity funds saw fundraising increase by 11x, outpacing deal flow growth of just 4x. Meanwhile, small-mid funds experienced more stable capital supply-demand dynamics with just 3x growth in fundraising and 4x growth in deal flow over the same period. This has resulted in a consistent discount in small-mid buyouts relative to large ones, which today stands at around 5-6x EV/EBITDA.

Entry valuation discount in small-mid buyouts

Past performance is not a guide to future performance and may not be repeated. The views shared are those of Schroders Capital and may not be verified. For illustrative purposes only and does not constitute a recommendation to invest in the above-mentioned security / sector / country. Source: Schroders Capital, 2023. Capital IQ, Baird Global M&A Report.

Small-mid buyouts also benefit from an added exit strategy facilitated by strong fundraising among large buyout funds: selling their portfolio companies to large buyout funds.

Our analysis of Preqin data from over 49,000 private equity funds showed that small-mid funds typically yield higher returns in terms of net total value paid in (TVPI) basis and net internal rate of return (IRR) basis. The outperformance is also demonstrated across geographic regions and during recessionary periods.

Small-mid private equity funds have delivered higher net returns than large private equity funds

Past performance is not a guide to future performance and may not be repeated. For illustrative purposes only and does not constitute a recommendation to invest in the above-mentioned security / sector / country. Source: Preqin, Schroders Capital, 2023. Period covered 2000–2017. Performance numbers are net to investors. Performance data reported as of 31 December 2022. Fund size classification: Small: fund size below $500m; Medium: fund size between $500m and $2000m; Large: fund size above $2000m. Fund of funds and single asset funds excluded.

The domestic growth story in China and India continues to offer exciting private equity opportunities

China remains an attractive region for private equity, driven by domestic opportunities from import substitution and consumption upgrade themes. Onshore RMB funds are particularly compelling as they focus on small-mid deals and represent the largest pool of private equity capital in China. They are also better shielded from geopolitical factors that cloud the exit route for China USD funds.

Technology sectors, specifically advanced technology and manufacturing, as well as green technology, stand to benefit from import substitution. China’s consumer sector also holds attractive opportunities. In 2020, Schroders Capital invested in a top Chinese designer toy brand, capitalising on the large Generation Z demographic and rising preference for local brands.

We also favour India for private equity as it is expected to become the third-largest global economy by 20281 thanks to its demographic advantages, strong digital adoption, thriving manufacturing base, and ability to serve as a key “China plus one” partner. Private equity offers unparalleled access to India’s economic growth, with companies operating in the fastest-growing sectors – consumer, healthcare, and technology – being overwhelmingly privately held. In 2016, Schroders Capital directly invested in a leading eyewear company in India, thereby gaining exposure to growing disposable incomes and digital adoption.

Fast-growing sectors dominate India’s private equity market, while traditional sectors prevail in private markets

Source: PitchBook Data, Inc., BSE Ltd., Schroders Capital, 2024. For illustrative purposes only and does not constitute a recommendation to invest in the above-mentioned security / sector / country. Note: Technology is a broad sector which includes traditional IT services, enterprise software, hardware, fintech, social media, and e-sports. Financial Services includes traditional retail banks and insurance.

Schroders Capital: consistent track record in private equity with access to specialised opportunities

Schroders Capital, the private markets investment division of Schroders, is a leading global private assets manager, managing US$94 billion assets under management (as of December 2023) across a diversified range of private asset investment strategies: private equity, private debt and credit alternatives, real estate, and infrastructure.

With a successful track record spanning 25 years, our PE expertise spans buyouts, secondaries, venture capital and growth, as well as emerging markets. We are experienced buyout investors with a focus on specialised markets with a global perspective, sourced primarily from family and founder-owners, having long-standing relationships with the best-performing and most trusted GPs within the sectors in which we operate.

Our key differentiator lies in targeting the “long tail” of small to mid-market deals, where we find significant value-creation opportunities.

As private markets evolve, we believe our skill set, experience and network will continue to drive positive outcomes for our clients.

Discover a world of investment opportunities here.

1 Source: IMF GDP estimates, Schroders Capital, 2024.

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This is a sponsored article from Schroders Capital.

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