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Lessons for private equity from the last downturn

McKinsey 15 Apr 2020 12:00

One phrase heard often these days in (video) conversation with private equity professionals is, “We have been expecting a downturn for a long time—just not this one.”

Of course, the havoc that COVID-19 has wrought on lives and livelihoods the world over is much more than a downturn; it is a global crisis whose human toll is yet to be understood, much less accounted. But it is also an economic downturn. This raises the question: To what extent are the lessons of previous downturns relevant?

The private equity (PE) industry is still fairly young, though old enough to remember 2008. We looked briefly at two aspects of how the industry confronted the last economic downturn for hints on what may drive value in this one. In brief: operating groups appear to matter; and “buying low” is great, if you can.

PE firms with portfolio value-creation teams outperformed in the last crisis

We analyzed 120 of the largest PE firms, which included many with specialist teams focused on driving value creation in portfolio-company operations, and many without such teams. We compared their investment returns and their fundraising over 2004–18, looking at five-year periods before, including, and after the global financial crisis that started in 2008 (Exhibit 1).

Before and after the crisis, both groups of firms performed comparably (about 13 percent net internal rate of return (IRR) for vintages 2004–08 and about 21 percent for vintages 2014–18). But during the crisis years, firms with value-creation teams meaningfully outpaced the others, achieving about five full percentage points more in IRR (23 percent) than firms without portfolio-operating groups (18 percent).

It is hard to be entirely wrong when arguing that investors should seek to buy low and sell high. Yet it is, of course, not quite that simple. Today’s “low” may turn out to be tomorrow’s “not yet that low.” The cheap debt financing that was so plentiful a few months ago is suddenly scarce. Many sellers are less excited to exit at current prices.

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