Private Equity Produced Negative Return in First Quarter

By David G. Barry

For the past several months, chief investment officers have been readying their boards for a downturn in private equity. That decline, however, may be more significant than many CIOs forecast.

According to a report presented by the StepStone Group to the Equity: Public/Private Committee of the Board of Investments of the Los Angeles County Employees Retirement Association (LACERA), the private equity industry during the first quarter produced a negative 1.3% return. In contrast, the segment generated returns of 5.6% during the fourth quarter of 2021, 7% during the third quarter and 13.6% during last year’s second quarter.

There has been considerable interest in the numbers, given that private equity results are a quarter behind those of other asset classes, like public equities and bonds. As a result, when public pension funds reported the results for the quarter ended March 31, they included private equity results that were from the quarter ended Dec. 31.

The numbers presented by StepStone provide a peek into what public pension funds and endowments may be displaying this summer when they roll out results for the quarter ended June 30.

StepStone Group Partner Natalie Walker, who addressed the LACERA committee, said “Q1 was a very different story” than 2021 for private equity, owing to an “extremely volatile market” resulting from Russia’s attack of Ukraine and supply chain disruptions.

The first quarter, though, will likely not be a one-time blip for the private equity industry, said Walker.
“We do expect further declines in the second and third quarters,” she said. “But we remain optimistic that the long-term nature of private investments will continue to serve LACERA well.”

Venture capital had the worst first-quarter results within the private equity segment, according to StepStone. It declined 4.1% after returning 6.9% in the fourth quarter, 8.7% in the third and 15.3% in the second quarter.

Buyouts – or the more traditional private equity – showed a 0.7% decline after generating 5.5% in the fourth quarter, 6.8% in the third and 13.1% in the second quarter of 2021. Growth equity, meanwhile, declined 3.9% after showing gains of 3.7%, 6% and 13% over the preceding three quarters. The one part of private equity which showed a positive return in the first quarter was described by StepStone as other, which would include secondaries. It generated a gain of 1.2% but that too is down from the 5.3%, 6.9% and 17.1% it generated in the last three quarters of 2021.

The buyout sector, she said, was “flat” compared to the VC and growth equity sectors – sectors which specifically felt the impact of the drop in technology stocks. That being said, she does not expect a slew of VC and growth equity-backed companies to close down. Many of these companies, said Walker, have a “couple of years of cash runway” and have “been quick to act and play defense.”

On the buyout side, she said the companies appear to be well financed, meaning it may take a while for distressed buying or market dislocation opportunities to present themselves into investors.

A key reason for the decline in returns is that initial public offerings and mergers and acquisitions of private equity-backed companies also fell in the first quarter.

According to StepStone’s presentation, only eight companies were able to go public in the first quarter, raising $1 billion. That’s a 96% decrease from the 46 IPOs and $26.8 billion raised in the fourth quarter of 2021. Private-equity-backed M&A transactions declined from 933 in the fourth quarter of 2021 to 630 in the first quarter of 2022.

Returns were not the only thing that fell in the first quarter. Deal activity was down 25% from the first quarter of 2021 and global private equity fundraising was down 13% from the fourth quarter at $245.7 billion.

Walker also said that funds raised by U.S. managers accounted for 69% of the total during the quarter, up from the 10-year average of 62.1%. In contrast, European managers accounted for only 15.8% of the total, down from the 10-year average of 22.6% – a figure that she attributed to the volatility caused by Russia’s invasion.

StepStone, she said, does expect the fundraising pace to be down in 2022 compared to 2021. Walker described this as a positive trend as it will lead managers to be “more judicious” with their investing activity and slow their fundraising activity. This, in turn, will provide relief to pension funds and others who have had to deal with firms constantly raising new funds.