If it has not lived up to expectations, and another expensive infusion of cash is out of the question, then naturally valuations will drop, dramatically. Losses could especially be understated in the real estate part of that market.
The end of the US fiscal year for pension funds, at June 30 2023, could reveal some surprises.
Private equity meltdown
What are the market repercussions of a potential private equity meltdown?
The largest problem with the private equity market is that it is opaque. No one knows the underlying figures and potential exposure to risk.
It could be argued that the implications from the potential implosion of the private equity market are not systemically important. After all, that was the plan — take the risks away from banks and put them on private investors. The private equity market is not very big.
The total value of private equity capital invested worldwide in 2022 was an estimated $12tn, with $3.7tn in “dry powder”, capital pledged but not deployed, according to Statista. This figure is dwarfed by both the global equity market, which is worth $109tn, and the global bond market, which at the end of 2022 was $133tn.
However, history has proven that this may not be the case. Assets tend to find connections we currently cannot account for.
In 2007, the US subprime mortgage market was estimated at $1.3tn, a 10th of the current private equity market and just 14 per cent of the total mortgage market. Yet, its implosion — which was not wholesale — sparked the largest financial crisis in a century, the consequences of which are still visible today in every sphere of the economy, finance and politics.
Having said that, we think that the final impact will probably prove muted. Not because it is an isolated market, but rather because the Fed has a sound strategy, which it deployed during the March banking crisis.
At the first sign of a credit crunch, it will deploy credit lines and other measures very quickly and at strength, which may help put out the fire early. Those measures expand the balance sheet but do not necessarily counter rate hikes, as they have little impact on long bond yields (other than reducing their volatility) and thus mortgages. The tactic worked after the collapse of Silicon Valley Bank, keeping risks at bay.
When do we think risks for the private equity market will abate?
The short-term outlook is challenging. Valuations will be lower and capital is less readily available. The longer-term outlook is also not necessarily positive.
