2018 Outlook: Looking for opportunity in private equity and stressed credit

With valuations elevated, there is a lower margin of error and less certainty of returns to absorb unanticipated risks

Dec 12, 2017 | Patrick Machir

The overall global macroeconomic picture saw gradual improvement in 2017, aided by continued supportive monetary policy from central banks throughout key economic centers. We entered the year expecting volatility, in part due to the implications of the US presidential election. However, lower volatility took hold as markets grew comfortable with a range of uncertain issues, including potential policy changes from Washington, China’s economy and the overall interest rate and commodity environment.

We expect that 2018 may see an increase in volatility as the economic expansion in the US enters its ninth year. While our base view is for a continuation of the current economic expansion, there is a higher degree of uncertainty beyond 2018. We are monitoring several key themes that each play an important role in the private equity and stressed credit universes.

Valuations and leverage

The combination of synchronized global monetary stimulus, significant availability of credit and the large amount of dry powder has created a receptive climate for leveraged buyouts in recent years. However, as purchase multiples have moved up, average equity contributed to transactions has remained at higher levels than prior to the financial crisis. Further, increasing participation from sovereign wealth funds, family offices and other new pools of capital has resulted in more deal competition for traditional private equity investors.

These factors, combined with a rising interest rate environment, serve to put downward pressure on the implied return potential of the traditional leveraged buyout and limit the ability for returns to absorb unanticipated risks.

 

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