Private equity, particularly buyout funds, has become a significant source of returns for institutional investors. Public pension fund private equity allocations averaged 10.1% in Pensions & Investments' latest survey, compared with 8.2% five years earlier, with buyout funds making up about two-thirds of the total. The asset class' seemingly low volatility makes it particularly attractive when risk-adjusting those returns, but subjective and lagged valuations can mask volatility and create a false sense of security.
Strategy of choice: About $933 billion in capital was targeted by private equity funds in 2020 through mid-April. Buyout funds were more than one-third of that total.
Slow to react: MSCI's "nowcast" model estimates values of buyout funds based on public and private market data. The model shows general partners reporting fund values at a premium during times of market stress but steep discounts during rebounds.
Higher debt: Buyout portfolio companies show higher debt levels than those of public microcap and small-cap companies. Despite their ownership structures, portfolio companies still run in the same economy, needing revenue to repay debt.
Things could get tight: Microcap and small-cap company revenues have been hit much harder amid the COVID-19 pandemic than large caps, while their more stagnant debt structures have changed little by comparison.
*IRR starting January 2006. **IRR starting January 2018. Sources: Preqin Ltd.; Bloomberg LP; MSCI Inc.; The Burgiss Group LLC