The Best Private Equity Returns Come After a Recession

“Past lessons have taught PE investors the value of waiting out the storm,” according to Bain Consulting’s Hugh MacArthur and Brenda Rainey.

Bigstock photo

Bigstock photo

Private equity investors have little to fear from a recession, as the best returns come after these periods.

According to the latest midyear private equity report by Bain Consulting, investors earn superior internal rates of return in years following recessions. For example, following the bursting of the dot-com bubble, buyout funds generated a median IRR of 25 percent in 2001, 40 percent in 2002, and 47 percent in 2003. In 2009, after the Global Financial Crisis, they posted a 24 percent IRR. In general, PE investments during recovery years have “consistently outperformed the long-term averages, especially investments in top-quartile deals,” according to the report.

Things are likely to be no different this time around. Private equity deal activities were down in the first half of 2022 as investors battled with persistent inflation, aggressive rate hikes, and rising geopolitical tensions.

Investors’ actions seem to reflect Bain’s report: 96 percent say they would invest in private equity funds in 2022, according to Preqin. “Past lessons have taught [PE investors] the value of waiting out the storm,” wrote Bain’s Hugh MacArthur and Brenda Rainey, members of the firm’s global private equity practice team.

In the Bain report, MacArthur and Rainey noted that if history is any indication, the macroeconomic headwinds faced by PE investors are not likely to last long. “Inflation cycles have historically been sharp and short, with rising prices interrupted by recession,” they concluded, after studying the macroeconomic data since 1956. As for the current down cycle, they predicted that “the current inflation spike could precipitate a recession that starts in September, peaks in October, and then drops back to the long-term trend by September 2023.”


But in the near term, private equity firms still face a bumpy road ahead, despite the potentially short duration of the market downturn. One reason is that the public market woes have put the brakes on the exit activity of PE firms. In the first half of 2022, the value of global buyout-backed exits was $338 billion, down 37 percent from the same period last year, according to Bain, while global IPO value was down 73 percent. “As this period of turbulence wears on, the slowdown will likely extend to exits across the board,” the report said.

According to MacArthur and Rainey, there are several due-diligence adjustments that PE firms can make to better withstand the inflationary pressure. As Institutional Investor previously reported, the speed at which PE managers vet companies began to increase in the summer of 2020, and it hasn’t slowed since. With all the valuable deal information available, managers should conduct scenario analysis, stress-test their portfolio and target companies, and avoid drawing conclusions based on a company’s past performance, according to the Bain report. It would also be helpful to look for companies that can protect their profit margins by passing on the rising costs to consumers.

“PE funds need to manage proactively to anticipate change and get ahead of it,” the authors concluded. “That will be critical in weathering this period of turbulence and taking full advantage of the recovery to come.”