Bullish projection in report published by alternative assets specialist; political and environmental risks also lie ahead.

A recent report by Preqin, a financial data company focused on alternative assets, predicts that private equity assets under management (AUM) will reach $9tn by 2025. This would result in more than doubling the current market cap of $4tn.

In common with many industries, 2020 has been a challenging one for private equity and venture capital (PEVC). This year saw the reversal of a ten year growing trend in AUM, with a decrease of $70m compared to 2019. The major culprit behind this reversal was, of course, the global coronavirus pandemic. This week’s promising vaccine update by Pfizer and BioNTech, coupled with the likelihood of a Biden presidency with a republican-controlled senate signals the possible resolution of two of the major traumas of 2020. Both could contribute towards a return to form for PEVC.

There are several other reasons to support the optimism of Preqin’s report. However it’s important to recognise that significant risks - particularly political and environmental - continue to loom on the horizon.

Private equity retains dominant position within alternatives

First the reasons to be cheerful. Despite this year’s setbacks, private equity has retained its position as the dominant asset within alternatives, accounting for over 40% of all global alternative assets under management. The FT reports that in a year of sell-offs, many of America’s wealthiest citizens have concentrated efforts to raise cash on liquidating other assets first, before turning to PEVC. Both support the argument that this year’s sector performance may not have been as downbeat as it first seems.

Preqin projects that PEVC’s annual growth rate of 15.6% over the next five years will outstrip the 9.8% for alternative assets as whole. It puts this down to a continued investor shift away from actively managed public equities, with PEVC the main beneficiary from the general redirection of funding towards alternatives. Historically low interest rates will continue to support leveraged buy-outs. Outsized growth potential is seen for private equity in Asia-Pacific; so long as China continues to move towards more transparent financial institutions and products.

Could a change to taxation be in the offing?

Reports of the UK treasury reviewing tax regimes sound a note of caution. Governments the world over need to refill coffers after splurging on healthcare, jobs support and stimulus programs in response to the pandemic. Private equity has been a favoured son of the UK taxman ever since a famous meeting involving Norman Lamont, then a senior treasury minister and Jonathan Blake, a lawyer representing the interests of private equity executives. That meeting led to a policy of taxing the multi-million pound bonuses of PE execs at a lower rate than regular higher rate income tax. Where London led, the US and many European countries followed, implementing tax breaks of their own. Who’s to say that this might be the case once more, with the UK leading a general global trend towards increased taxation across PEVC as whole?

Fund managers look to reduce the temperature of portfolios

Environmental concerns are not going anywhere. As public awareness of climate change and action against it has grown, so too has fund manager concern for the potential negative impacts on investments. Of fund managers surveyed by Preqin 9% see climate change as having a significant negative impact, with a further 33% seeing it as a slight negative. Technology may have the answers, and the pandemic-accelerated trend towards PEVC investments in e-commerce and technology is expected to continue. Fund managers will put increasing emphasis on reducing the temperature of their portfolios and more closely scrutinising the sustainable credentials of investee companies.

Finally there’s the small matter of president-elect Biden. The final senate run-offs in January 2021 will determine the balance of power; with a Republican majority expected by most analysts. His stance on China, taxation and a number of other areas will influence private equity performance throughout his first term. However his ability to make deals with republican senate leaders may be the biggest determining factor.

Dot bottom line: There are many reasons to support the optimism of Preqin’s projections. Prospects for private equity and venture capital investment look strong in the medium term. Challenges also lie ahead. Mitigating and managing these risks will go a long way to determining the winners and losers within the sector.

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