PE Valuations Drop — But Still Remain Far Above Public Markets

Valuations declined 1.7 percent between the second and third quarters of 2022 in private markets, which includes buyouts, venture capital, funds of funds, real estate, infrastructure, and natural resources, according to the latest report from eFront. Although the data is based on an analysis of over 7,300 funds in the private market, most are buyout and venture capital strategies.

In buyouts and venture capital, valuations dropped 2.4 percent and 2.3 percent in the third quarter, respectively. The decline marked the third consecutive quarter where funds in both sectors lost value.

“After the initial shock brought on by the Covid-19 pandemic, the private equity market bounced back to multi-year highs for a sustained period,” according to the report. However, in the first quarter, “in part as a result of the shock to markets in the wake of Russia’s invasion of Ukraine, returns slumped.”

Despite having data for only three quarters, private market funds still appear to have fared better than their public counterparts. In 2022, the S&P 500 index lost nearly 20 percent. But critics argue that the outperformance of private equity funds is an illusion because the valuations of private companies are determined by committees — and only on a quarterly basis.

“Theoretically, they are equally as exposed to left-tail risks [as public equities],” said John Lidington, senior client portfolio manager at Man Numeric, a quantitative investment management subsidiary of Man Group. In a recent paper, Lidington found that there’s a 76 percent correlation between the Russell 2500 index, which includes public companies, and the U.S. Private Equity Index developed by Cambridge Associates.

“If there are short-term blips in the market, where the public market is selling off and fairly quickly rebounding after that…then I wouldn’t mark my portfolios down either [if I’m in private equity],” Lidington said. But when there’s a prolonged market downturn driven by a regime shift, private equity valuations should catch up slowly with public markets, he added.

The decreasing valuations of private companies is also reflected in the secondary market. Seventy-five percent of private companies traded at a discount in the fourth quarter, up from 50 percent in the third quarter, according to Nasdaq Private Market.

Tom Callahan, CEO of Nasdaq Private Market, said investors should have expected the valuation declines.

“I think we can comfortably say without much controversy now that across most asset classes, including the private markets, there was a liquidity-driven bubble in 2021,” he said. “And that drove valuations in a lot of asset classes, including private markets, to extremes.”

But investors shouldn’t extrapolate too much from the recent declines in secondary markets. “The deal volumes have dropped so significantly that you have these very isolated data points,” he said.