Yahoo Finance

Despite recent volatility in the asset class, Commonfund, the multibillion dollar asset manager that constructs portfolios for foundations, endowments, pension funds and family offices, remains bullish on private equity.

"We're in a period of stress, not distress," said Mark Hoeing, president and head of buyout and growth equity, at a media roundtable on Wednesday.

While PE faces threats to its financing structure and mounting competition, the asset class has pockets of safety in low- and middle-market and highly specialized funds.

Over the past year, private equity's market foothold has taken a hit. The Federal Reserve's interest rate hike campaign resulted in high borrowing costs, inflationary pressures plagued the broader market, and public equities came down, overweighting the private market portions of many institutional portfolios. In response, LPs slowed the capital spigot: From Q1 2022 to Q1 2023, total PE fundraising across the six largest public alternatives managers declined 33.8%, according to PitchBook's US Public PE and GP Deal Roundup report.

Some firms were more insulated from market pressures than others. With investment preferences in lower and middle-market PE deals that require less leverage than larger and more expensive buyouts, and a prominent growth equity strategy that avoids debt completely, the effects of the rising cost of debt have been "much less pronounced" in Commonfund's private equity portfolio, said Miriam Schmitter, the firm's head of buyout and growth equity investments outside of the US.

Commonfund's strategy is part of a growing trend of outperformance in the middle and lower ends of the market relative to some of the industry's largest funds. In Q3 2022, US PE middle-market funds—defined as between $100 million and $5 billion in size—rounded out the quarter with a median one-year horizon return of 9% compared to mega-funds that returned only 4.2%, according to PitchBook's Annual US PE Middle Market report. This is a reversal from previous quarters, when mega-funds dominated performance. 

"Middle market funds do not rely on billions of dollars in financing for acquisitions, which has forced mega-funds to be more creative in the deals they pursue," said Kyle Walters, private equity analyst at PitchBook.

Also, check sizes written to middle-market funds are typically much smaller than those committed to mega-funds—a plus for capital-constrained LPs, Walters said. 

Fueled by LP demand, middle-market PE's favorability is expected to continue. In a Coller Capital survey of 100 investors in PE funds, over 80% of respondents said they expect to see good investment opportunities for GPs in mid- and lower-mid market buyouts and special situations over the next two years.

Commonfund sees the greatest opportunity in mid- and lower market players that are highly specialized in sectors like healthcare and SaaS, and firms are responding to this demand for specialization. "Certainly within mid-market PE funds, we're seeing more specialized funds coming to market," said David Fowler, global co-head of product for Apex Group's PE practice.

Up until last year, the past 12 years were up-and-to-the-right for PE. From Q4 2012 to Q4 2021, PE funds' rolling one-year horizon IRR saw a 31.5 percentage point increase, according to PitchBook's Global Fund Performance Report. 

Today, the industry finds itself at an impasse: The PE market, which reached a record $4.9 trillion in 2021—almost double its size in 2012—has outpaced the amount of LP capital, Hoeing said. With fewer fundraising dollars and a record number of industry participants, he said the current private equity market is more competitive than it's ever been.