• Almost 50% of firms surveyed by Private Equity Wire believe that returns in PE will decrease

• Private equity returns fell to their lowest since Q1 2020, dropping to 6.8% in Q3 2021

• LPs intend to reallocate with strong performing GPs who have a long-term plan for their fundraising

After two years of record benchmark returns, some limited partners in the asset class are confronting the reality of below-average performance, with a survey by Private Equity Wire predicting average returns will continue to fall in H2 2022.

The research forms part of the latest PEW Insight Report, H1 Update: Private equity faces bear market.

Falling from almost 15% in Q1 2021, average global returns fell to 6.8% in Q3 2021 – the strategy’s lowest quarterly IRR since the pandemic rocked public markets in Q1 2020, according to Pitchbook. In Q4 2021, returns rose to 7.7% but dropped again at the start of this year in preliminary data.

Yet despite declining average returns post-pandemic, private equity funds that can outperform are set to remain popular with investors.

“I think that this is just a burgeoning asset class that will continue to grow. When you’re invested in your [fund] vehicle, you’re probably not sweating quarterly marks as much, but if you’ve got more of a liquid portfolio, and may be far more driven by public markets, then you’re concerned,” says Simon Finn, managing partner at Intriva Capital.

LPs such as UK pension pool Border to Coast remain optimistic but realistic about prospective returns.

“I suspect that private equity returns won’t be as strong over the next few years, particularly compared to performance last year. 2021 was a banner year for most firms, particularly from an equity perspective, so it would be hard for returns to continue at that level. But we do still expect private equity returns to be favourable versus public market equivalents, mostly driven by the illiquidity premium,” says portfolio manager Christian Dobson.

The latest Coller Global Private Equity Barometer reported that 70% of LPs stated that private equity portfolios outperformed public equity portfolios since the financial crisis.

Though most active LPs aren’t fazed by lower quarterly benchmark returns in the short-term, some are reconsidering how they will allocate to the asset class in the future.

As well as looking through to long-term performance, there is also a desire to allocate to top-tier fund managers when the opportunity arises. Manager selection will prove key to LPs in the coming months, with investors evaluating and seeking out the best manager talent for their portfolios, say sources.

“One of the biggest challenges LPs are going through is how to choose the best managers. There are a lot of good managers who performed well and they probably are going to run into some challenges since they’re not going to make the roster with every LP,” says Bradley Young, global CIO, private markets, Mercer.

Key Takeaway | GPs: LPs are streamlining their portfolios and seeking out the best manager talent in the space to counteract and prepare for predicted quarter-to-quarter drops in benchmark returns