When Not to Quit

October 26, 2022 | Amy Miller, Senior Research Analyst

Two-line chart showing private equity valuation discount. Chart subtitle: Contracting multiples can lead to attractive buying opportunities. Chart visual description: Y-axis is labeled Median EV/EBITDA Multiple and ranges from 0.0x to 22.0x. X-axis shows years from 2009 to 6/30/22. First line is dark orange and represents U.S. Middle Market PE and second line is gray and represents Russell 3000 index. Chart data description: For all but two of the years shown in the chart (2009, 2011), the Russell 3000 index has had a higher Median EV/EBITDA Multiple than the U.S. Middle Market PE. Though in the earliest years shown the two were within decimals of each other, it has since mostly hovered at 1-3x, and peaked in 2020, with the Russell 3000 at 20.2x and PE at 12.7x, representing a nearly 60% difference. Both have since come down; as of June 30, 2022, R3000 is at 12.9x and PE is at 11.4x. Chart source: Pitchbook as of June 30, 2022. End chart description.

One of the oft-touted advantages of investing in private equity is the opportunity to buy in at a discount to public markets. This valuation discount, as measured by EV/EBITDA multiples, has persisted since 2012, widening to nearly 60% in 2020.¹ Since that peak, the discount has narrowed significantly as public market equities have sold off. While this may give some cause to pause, it is interesting to consider what transpired for investors between 2009 and 2012, on the heels of a near-meltdown of the financial system. With equities down sharply into 2009, the denominator effect boosted percentage allocations to private equity within investor portfolios. The instinctive reaction (and in some cases, forced action) may have been to abstain from new private equity investments beginning in 2009 so as not to exacerbate the over-allocation. This may sound familiar to private equity investors in 2022.

With hindsight being 20/20, these corrections to annual capital commitments ultimately resulted in an under-allocation to private equity, and thus underperforming portfolios over the next decade, as public markets and public market allocations snapped back. Furthermore, while private equity will likely not see the type of drawdown that public markets have seen, we do expect valuations to pull back, creating attractive entry points for managers with dry powder to deploy capital. While investors should be mindful of any liquidity constraints and maximum allocations to private markets, those that are able to remain steadfast in their annual commitment pacing schedules may find themselves in a better position once the public markets settle. Marquette believes that a successful private equity program is one that is consistently diversified by vintage year over time and highly selective in terms of manager partnerships.

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¹Pitchbook, as of June 30, 2022