A very liberal outlook on investment banking and insurance practices precipitated the housing bubble that led to the 2008 financial downturn.
According to private equity expert and AFL aficionado, Darren Herft, the roughly $9.8 trillion investments by private equity players in unlisted equity and private credit among other investment vehicles might portend another crisis.
“The current market presents numerous concerns – overly cheerful expectations, aggressive investing, over appraisal and higher than normal debt levels being some,” says Darren Herft.
He contends that lack of liquidity accorded by private investment vehicles presents investors looking to cut losses with a formidable challenge.
“Liquidation is especially challenging in the present scenario as it depends on initial public offerings and trade sales which cannot be expected at previously projected rates,” claims Darren Herft.
The Australian entrepreneur thinks that private equity players could be forced into distress sales or restricted by limitations on withdrawals due to discrepancies between their ability to realize assets and redemption rights. Moreover, unclear market prices due owing to lack of market prices might lead to miscalculated investments or funds.
“Given current Market volatility, private equity firms should anticipate a tougher fundraising run.”
Four of the largest publicly traded PE firms reported losses for the June quarter. For PE giant Apollo, the quarter marked a second consecutive round of losses. Even as the rising rates and unpredictability of the market have driven down the price of their holdings, some of the larger PE players continue to be aggressive.
While the decline in PE fortunes is markedly lesser than their S&P 500 counterparts, Darren Herft thinks that pummeled stock values could present a stopper to the flow of new capital to private equity due to its illiquid nature.
The Australian PE expert believes that this might lead to many private equity funds failing to achieve their original goals due to fundraising bottlenecks. However, the allocation limits and pressure from the denominator effect on institutional investors hasn’t deterred their clients and other private equity players to fast-tracking their pace. The Denominator Effect occurs when the value of one portion of a portfolio decreases drastically and pulls down the overall value of the portfolio.
Darren Herft thinks that while PE executives might be gaining confidence due to new private markets, they should still be wary of the implications of the denominator effect.
“Even as private equity has proven its resiliency in the face of a global pandemic and conflict in Europe, a more conservative approach during such volatile times might serve investors well in the long run,” says Herft.
