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Private equity firms seeking fresh capital from limited partners—namely, almost all of them—could soon face mounting competition from investment-grade and US Treasury bonds.

The sustained elevation of interest rates and supply dynamics in the Treasury bond market have boosted the yields of those tried-and-true investments, increasing their appeal for allocators while PE fund distributions have plummeted, according to PitchBook's latest Quantitative Perspectives report.

A bond sell-off drove the yield on the 10-year Treasury note to 4.9% as of Oct. 31—the highest point since 2007. For the first time in over a decade, it also surpassed the S&P 500, where equities yielded 4.6%, per the report.
   
Cheaper long-term bonds could be around for a while.

In the next 12 to 15 months, the Treasury will likely have to issue a high volume of long-term bonds to fund increasing deficits, said Andrew Akers, PitchBook senior quantitative research analyst and author of the report. That expectation lines up with less demand for long-term Treasuries as commercial banks and the Federal Reserve—historically acting as buyers in that market—have flipped to become net sellers as they reduce their overall exposure.

Allocators are likely to show renewed interest in Treasury bonds, which historically provided a baseline of predictable returns on investment. In 2021, low bond yields forced some institutional investors to look outside of their typical risk profile in order to realistically meet investment performance targets.

"When you can get 4.5% to 5% on your Treasury portfolio, that can again become a core, foundational part of your portfolio," Akers said. "On the margin, I think investors are going to be able to look toward bonds, and that capital is going to be taken from other, risky parts of the portfolio."

While bond yields have recovered, PE's outsize fund performance of recent years has been touching back down to reality alongside the rest of the private markets.

For PE funds, one-year-horizon IRRs stood at 1% through Q1 2023, the latest quarter for which comprehensive data is available. That's far below IRRs on three- and five-year horizons, which stood at 25.6% and 17.8%, according to PitchBook's latest Global Fund Performance Report.

The challenge of higher expected returns from bonds arrives as the PE industry faces other struggles that could pressure fundraising in 2024, mainly tied to the industry's low exit rate for existing investments.

Realizing returns on active investments has been difficult. PE exit value fell to its lowest level in at least 30 years in Q3, and the mean holding period for PE-backed companies has increased, according to the Quantitative Perspectives report. Virtually every industry and deal type has seen fewer deals and lower value among the deals that are left.
   
Meaningfully for LPs, fewer exits has meant lower distributions: The trailing 12-month calculation of buyout fund distributions as a percentage of a fund's starting net asset value has fallen to 11%, down from 37% less than two years ago, according to the report.

Using a PitchBook fundraising forecasting model, the report shows how the effects of those lower distributions could slash PE buyout fundraising in 2024 to 30% below recent trends.

"There's going to be less demand for commitments in 2024 to private equity strategies," Akers said.

Featured image by Douglas Sacha/Getty Images

This article originally appeared on PitchBook News