UBS has issued a comprehensive report outlining the key questions facing European private equity in what the bank is calling a “potentially critical juncture” for the sector.
According to the bank’s latest analysis, the recovery of deal volumes, the clearing of unsold assets and the sustainability of returns are key factors that will shape the future of private equity across the region.
The question is, who is best positioned to make it out on top?
Deal activity
Although there has been improvement, activity remains at roughly 50% of its historical average.
UBS suggests that falling interest rates could help drive a resurgence in deal volumes by lowering financing costs, yet challenges remain.
The bank highlighted a significant backlog of unsold assets that private equity firms need to clear to alleviate liquidity pressures and facilitate fundraising efforts.
Unrealised valuations
The valuation of unrealised assets in private equity portfolios is another major concern.
UBS warned that, in some cases, assets may need to be sold at discounted prices to facilitate transactions.
This valuation risk could have a major impact on returns, as firms might be forced to accept lower-than-expected exit values.
UBS stressed that if current economic conditions persist, with high interest rates and refinancing challenges, private equity returns could remain below historical averages for the foreseeable future.
Funding costs
UBS noted that higher funding costs, combined with the possibility of lower exit valuations, could result in reduced returns for many firms.
The report highlighted that European private equity firms may need to accept lower internal rates of return as part of a "new normal" where profitability is more difficult to achieve.
Fee pressure
One of the long-term concerns raised by UBS is the potential for fee margin pressure.
UBS pointed out that private equity funds charge relatively high management fees and carried interest, with management fees typically ranging from 1.5% to 2.0%.
As public market alternatives, such as liquid public market replication funds, become more sophisticated and widespread, there is a growing risk that private equity investors may shift their allocations toward lower-cost, more liquid alternatives.
Upsides
UBS said that public markets could play an increasingly important role in unlocking deal liquidity.
With a growing backlog of private equity transactions, initial public offerings (IPOs) may become a more significant exit route for private equity firms.
Historically, IPOs have accounted for only about 20% of private equity exits, but UBS suggests this could increase as firms seek liquidity through public listings, particularly as trade sales and secondary buyouts remain constrained by the economic environment.
If deal activity picks up and valuations remain stable, the industry could return to more normal growth rates, said analysts.
Hot tips
UBS highlighted Switzerland-based Partners Group and Jersey-based CVC Capital as strong candidates due to their diversified asset strategies.
Analysts suggested that these firms are better equipped to leverage new fundraising channels, such as private wealth, which is becoming an increasingly important source of capital for the private equity sector.
FTSE 100-listed Intermediate Capital Group (LSE:ICP) was also mentioned for its solid positioning across alternative asset classes.
On the other hand, UBS identifies Sweden’s EQT as a firm facing higher risks due to its significant upcoming fundraising needs and heavy concentration of unrealised portfolio assets, particularly in technology.