What the Future Holds for Private Capital [PitchBook]

Fund Fellow Founders What the Future Holds for Private Capital [PitchBook]

The report describes a data-driven framework for forecasting private capital AUM growth over the next five years, taking into consideration different macroeconomic scenarios and the impact on different asset classes within private capital. The report includes a good case, a base case and a bad case for each asset class, including private equity, venture capital, private debt, real estate and real assets. The report also details the methodology used for forecasting, including historical NAV and dry powder estimation, a modified Takahashi-Alexander model for forecasting cash flows and NAVs, and fundraising forecasts based on a linear trend model that automatically updates as the data changes.

Below you can find key takeaways from the report:

Our modeling includes a base case, a good case, and a bad case for each asset class.

PAGE 2 (Overview)

Private capital has accumulated over $10 trillion in assets under management, but with macroeconomic headwinds surfacing, what does the future hold for private capital?
As we turn the page on a tumultuous 2022, the alternatives industry is entering a time of high uncertainty. The growth of the industry depends on continued investor appetite and fund performance.
We have created a data-driven framework to forecast private capital AUM growth over the next five years. The estimate varies widely, depending on the global macro environment anticipated, and includes a good case featuring a return to economic expansion, a base case involving a moderate downturn followed by recovery, and bad case.

PAGE 3

Different asset classes within the private capital umbrella will be impacted in different ways by the sell-off in global public equity markets. We expect valuation markdowns to catch up with falling public growth stocks in 2023, and NAV growth will likely be negative in the near term for VC and PE.
Regulators and the denominator effect will dampen fund managers' abilities to grow their asset base, and LP sentiment is mixed. Shorter-duration asset classes such as infrastructure and private credit may see continued investor interest.
Our estimation methodology fit a flexible linear trend model to historical fundraising data and added a distribution yield component to reflect realized returns to LPs that are redeployed in future fund commitments. This methodology ties the cash flow and NAV models to the fundraising estimates.

PAGE 4 (Private equity)

The era following the global financial crisis was the golden age for PE fund managers, as low interest rates juiced up returns and increased discounted valuations, especially for the increasingly hot technology sector. However, we expect growth in PE assets to slow over the next five years.
To arrive at our estimates, we assumed that some near-term pain is likely for the asset class. In the good case, we see PE funds righting the ship quickly in 2023, and AUM grows to $6.5 trillion, buoyed by higher distribution rates and above-average growth in fundraising.

PAGE 5

The rapid growth of PE funds at the end of the last decade is expected to come down to a more sustainable pace.

PAGE 6 (Venture capital)

VC fund AUM reached $2.6 trillion by the end of 2021, but is at risk of further cuts as 2022 figures continue to come in. Additionally, startups that are nearing the end of their available cash may find it difficult to raise any capital.
Our base-case estimate for VC funds is underpinned by NAV markdowns of 10.0% and 15.0% in 2022 and 2023, respectively, which lead to AUM falling from $2.6 trillion to $2.1 trillion at the end of 2023.
Our bad case scenario projects a more pronounced NAV drawdown in the short term, with total AUM declining to $2.5 trillion over the forecast period. Our good case scenario projects a quick rebound of NAV growth to 20.0% starting in 2023.

PAGE 7 (Private debt)

The investor appetite for private debt has been supported by solid performance amid global central bank rate hikes and attractive yields. However, the risk of missed payments is worth watching closely with a looming economic recession and increasing cost of debt.

PAGE 8

Given the lack of run-up in prices over the past several years and debt being a less volatile asset class than equity, we forecast a rosier base case for NAV growth in the short term, including a 5.0% gain in 2022 followed by a 5.0% decline in 2023.

PAGE 9 (Real estate)

Since the GFC, global fundraising for finite-life, closed-end funds has remained relatively muted. Cap rates are at historically low levels, but will need to be pulled back, and a retraction in the business cycle would lead to headcount reduction, further culling demand for commercial office space.
Within closed-end vehicles, global AUM surpassed $1.1 trillion in 2021, with private NAVs showing little signs of devaluations. While fund returns in 2022 so far have not moved south, we expect the sell-off in public REITs and negative sentiment for the real estate sector to hit fund returns in 2023.

PAGE 10 (Real assets)

Real assets funds saw healthy but shifting investor appetite recently, with oil & gas funds suffering a pullback by institutional investors conscious of environmental, social & governance criteria. The trend is likely to persist as Western governments refocus efforts on building resiliency with their energy sources.
We expect infrastructure companies to see a bounceback in year-over-year AUM growth to 9.0% or more starting in 2024, and to grow 22.6% to $1.4 trillion by the end of 2027.

PAGE 12 (Historical NAV and dry powder estimation)

We estimate remaining capital overhang for vintage years by analyzing known cash flow and NAV figures from funds that we gather data on, and extrapolating the average pace of capital calls, distributions, and NAV growth to similar funds based on fund type and vintage year.

Modified Takahashi-Alexander model for forecasting cash flows and NAVs

We used a known industry framework for cash flow modeling to estimate the future NAV and dry powder of private, closed-end funds using aggregate vintage years as a single "fund".
The forecasts were created using historical fund cash flow and NAV data, and assumptions were made for different scenarios of growth rates. The models assumed a fund length of 18 years, with an adjustment made if there was still some remaining NAV in a vintage year that had already passed the 18 year mark.

PAGE 13

We used median historical one-year IRRs for each strategy from 2010 through H1 2022 as the baseline starting point, but made adjustments to the near-term growth parameters to analyze AUM forecasts under different market environments.

PAGE 14

We used bow factors to fit the implied, modeled NAV curve to the historical average NAV curve for each strategy.
We derived capital call rates from PitchBook's historical dataset and used the average percentage called down by year for each strategy to create cash flow curves.

Fundraising forecasts

We modeled AUM of closed-end funds several years into the future, and fundraising captured two components of the AUM growth process: capital recycling and new capital coming into an asset class.
Our fundraising forecasts were based on a linear trend model that automatically updated as the data changed. This model is simple and suitable for long-term forecasting.

PAGE 15

When distributions are average, the linear trend growth rate is a steady-state growth rate that combines new capital growth and capital recycling. Adding the trailing four-quarter distribution yield as a regressor to the base model improved out-of-sample forecast accuracy.

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