Navigating the New Normal in Private Markets

Navigating the New Normal in Private Markets

Anu Rajakumar: Investor appetite for private markets investments continues to grow, but what does uncertainty in trade policy and the economic outlook mean for private equity? What will the impact be on exits and distributions? How can investors capitalize on these dynamics while managing risks in today's market environment? My name is Anu Rajakumar, and joining me today to explore these themes and more is David Stonberg, Deputy Head of NB Alternatives and the Global Co-Head of Private Equity Co-Investments. David, welcome to Disruptive Forces.

David Stonberg: Thank you for having me, Anu.

Anu Rajakumar: David, this year, markets have obviously been roiled by the Trump administration's tariff proposals. Tell us about the impact of tariffs on private equity and how you think these ongoing discussions and negotiations might shake things up in the private equity space.

David Stonberg: Sure. It's obviously a very topical question, a timely one. It's one that we're hearing from our investors. It's one that we went out to our GP partners to talk to them about it and to see how is it affecting their existing portfolio companies? How are they thinking about it with respect to new investments? How are they thinking about it with respect to valuations?

We sent out a survey to over 100 private equity firms that we work with. It's a global group. It's buyouts, it's growth equity, it's venture capital. Some super interesting observations came out of the survey and thinking about how tariffs would impact the way they're looking at the world, their portfolio companies, et cetera.

One thing, just to step back and to understand, by a factor of basically 2 to 1, private markets versus public markets, private markets are invested into industries that are less exposed to tariffs. That roughly speaks to about 50% of portfolio company holdings are less exposed in the world of private equity, whereas 25% are less exposed in the S&P 500, using that as a barometer, if you will, for the public markets. What are those industries specifically? More service-related technology, the ones that are going to be less affected by tariffs.

When we asked the private equity firms, "What's the impact of the tariffs?" You would expect it to be lower than what you would see in the public markets. In fact, that's what we heard from our GP partners. Roughly 75% of the GPs that we spoke with, or I should say more formally that we had in the survey, expected no change to the valuations of their existing portfolio companies, specifically as an impact of the tariffs.

It may be other things that influence their valuations in their first quarter marks. Over 95% expected either no impact from Tariffs-- Now, when I say this, this is first order level. They're going to be derivatives from that on the overall economy, but directly impacted by. Over 95% expected either no impact or a moderate impact. That roughly broke out 50/50. Roughly 50% of the respondents said, "We expect no direct impact to our portfolio companies from tariffs." Another roughly 50% said, "We expect a moderate impact from tariffs."

That's across top line, that's across costs, that's across eBITDA. Less than 5%, some level of impact. Even with the ones who are expecting the moderate impact or the heavier impact, those private equity firms felt pretty good about their mitigation strategies, what they could do in effect to reduce the impact of those tariffs on their overall portfolio companies.

We should never lose sight of the flexibility and the nimbleness of private equity to be able to take advantage in markets like this. Some of the impacts and the effects of tariffs, the aggregation and the pooling of capital on the private equity side should be able to execute strategies that will be able to leapfrog other more entrenched competitors. Certainly, on the public market side, I believe, and in my opinion, to be able to attack some of the opportunities, whether it be reshoring or the creation of new supply lines, private equity may be able to fill the gaps there. Has there been an impact? Yes. Has it been as substantial as we have seen in the public markets? No. Does it create opportunity? Yes.

Anu Rajakumar: That's terrific. That paper, for those who are interested, it is published on our website, nb.com. It's titled Potential Impact of US tariffs: Private Equity Manager Perspectives. As you've said, some really fascinating and intriguing responses there. You've mentioned the uncertainty that is, of course, challenging to manage for any investor. What has all of this meant for distributions and exit rates? Are companies still preparing to go public, or are they holding off until there's more clarity?

David Stonberg: All right. Let's just set the stage a little bit. Distributions, broadly speaking, were down in the world of private equity, depending on how you measure them. On an absolute basis, not, but as a percentage of NAV, distributions were down about 50% over the last 2 years relative to the 10 prior years to that. We're talking about, roughly speaking, 25% of NAV being distributed on an annual basis, being cut to 12%, 13% of NAV being cut.

Now, we saw some green shoots in the fourth quarter of 2024 in terms of distribution activity, whether that was IPOs or whether that was sales to strategic, sales to other financial sponsors, but the creation of distribution activity back to LPs who were desperately craving it and asking for it. We could have a separate podcast specifically on that topic. The introduction of tariffs, as well as some other macroeconomic uncertainty that's been put into the system since then, certainly, all other things being equal, puts a dampener on what otherwise would've been a distribution activity this year.

Are we seeing things slow down? We are seeing things slow down on the distribution front, which is putting more pressure on the GPs.

Anu Rajakumar: Great. As I reflect on what you've said so far, it's an interesting set-up. You've got this economic uncertainty and limited liquidity, but also a lot of dry powder on the sidelines. I'm just wondering, what is the effect of all this on valuations? Are you seeing any shifts in how deals are being priced? I know, from your survey, you said a high number of the GPs felt there would be no change in valuations just based on tariffs, but there may be other factors. How are you thinking about all that?

David Stonberg: I would distinguish between the valuations where the GPs are saying this is where it's marked, versus where companies are getting sold when they're looking to transact on them. We're still seeing overwhelmingly an uplift in valuations from where companies have been previously marked when they do get sold, but there may be some selection bias in that.

Now from a valuation perspective, the assets that are still getting sold are the ones that are most protected from a tariff perspective. If there's uncertainty, it's hard for that business to get sold into today's market. It's interesting that you say what you said, Anu, there. There is, in my opinion, and it's a comforting dynamic, there is a lot of dry powder. Buyers, you would think, have pressure to put that to work.

There is a lot of pressure from investors to sell assets, but yet the market isn't transacting at that level that would suggest that. There's discipline from both the buyers and the sellers with respect to where they're willing to transact. I think that's healthy for the environment. One of the things that we track here at Neuberger Berman is the expected returns or the modeled returns that the private equity firms are looking at when they're underwriting their deals. This is on the ones that we co-invest in.

What we've seen over the last couple of years is that that return expectation has actually ticked up a little bit. I don't want to make it sound like it's gone from 20 to 35. It's a 100 basis points, 200 basis points. It's interesting to note that those private equity firms, as they're underwriting transactions in today's environment, are underwriting them to slightly higher expected returns than they had been for the previous 5, 6, 7 years.

I think that's an interesting dynamic and interesting to look at in, again, confidence boosting with respect to the discipline that's being exerted there. Do we see that showing up in sponsors selling assets at lower prices than they expected? Every once in a while. Again, I think there's also discipline on the sell side with sponsors looking for when they're saying, "Hey, I own this great business. It's doing very well for me. If now's not the right time to sell, now's not the right time to sell."

Anu Rajakumar: Yes. No, I really like that reframing that the discipline from both buyers and sellers is healthy for the market, and that has not come into an imbalance. We've alluded, several times, to LPs facing challenges with liquidity. Tell us a little bit about the opportunity to provide that much needed liquidity in a traditionally illiquid market. What does that mean for GPs and for LPs?

David Stonberg: Yes, sure. I'll probably get in trouble for saying this.

Anu Rajakumar: You're in trouble. Let's hear it.

David Stonberg: Yes, exactly. What is the pain for many LPs is the opportunity for us. Again, let's set the stage. The GPs are feeling pressure to get distributions back to investors and the market right now may not be the market that they want to sell assets into. How do they create that liquidity without losing control or selling assets at valuations that they don't want to do or prematurely? Where they're saying, "We don't want to sell control of this business today because we think the next five years is better than the last five years."

We have a number of strategies where we can work with those GPs to help them create that liquidity to send it back to their LPs. Top of the list is our GP-leds or continuation vehicles transactions where we are going in with those GPs, they are already selecting their most favored assets, the ones that they want to reinvest in, the ones where they think the next 3, 5, 7 years is more attractive than even the last 3, 5, 7 years of investments that have already worked out well for them.

They're reinvesting their own capital into those transactions. We, along with other participants in the market, get to set the price on those transactions, and that's a really interesting place to be. We think that's a super attractive part of the market. We can come in and create liquidity for those same GPs in minority equity where maybe they need that equity to go make an acquisition. Maybe they're looking to sell 10% of the company to send some distributions back to their LPs.

One of the things I didn't mention in here, everything that we're talking about, GPs are seeking, they're in the market trying to raise three times the amount of capital that LPs are looking to put in. There's a lot of pressure within the GP community to make LPs happy. "Hey, we want to get that capital back to investors." The GP-leds are one way of doing it. The minority equity deals are another way of doing it. Preferred equity, a third way of doing it, where we can come in and again support acquisitions for a business, maybe it's to take capital off the table.

Another way we can do it and some private equity firms are doing this more and more is selling a prized asset from their old fund to their new fund. We help facilitate that by being a valuation agent to help price the asset as that could be a potentially conflict transaction if they're on both sides of the trade setting, the valuation. There are lots of ways that we can help facilitate creating liquidity for those assets. We do this all with the GPs knowing we're not looking for control.

They continue to maintain control of the asset. Most likely, we're an LP with them, most likely we sit on their LPAC, and we don't compete with them in their core area of business. We become a very friendly capital provider. We can do this in size, and it creates an interesting dynamic for us and a market opportunity that we see as quite attractive in today's market.

Anu Rajakumar: I think that the place that your team sits is really just so unique, and again allows that long-term partnership with so many terrific GPs. David, I want to talk about innovations in private equity for a moment. This asset class has traditionally been one really accessed only by institutional investors, but that tide is, of course, turning with the introduction of new products, including evergreen funds, which are now accessible by a wider range of investors, including the retail market. What makes evergreen funds particularly appealing?

David Stonberg: Sure. I think there's two aspects to it, and I think implicit in your question is really two questions. One is, structurally, what's the benefit of an evergreen vehicle? There are a number in there. One is the compounding effect, the reinvestment effect that you get through an evergreen structure, which is an asset gets sold, liquidity gets created, rather than holding onto that liquidity in the investor's hands, waiting to redeploy it in the next private equity fundraise, that gets reinvested more quickly through the dynamic of the evergreen structures.

The evergreen structure also allows the investor, at a lower minimum, to be able to access a diversified portfolio of investments that are already up and running. It could be multi-manager, you get the diversification, and you can do it fee efficiently. There's structural advantages for that new individual investor to be able to access. There's also some liquidity provided in those structures. You want to read the fine print carefully around the liquidity provisions in those structures.

Also implicit in your question is, is now a good time to be investing into those structures and really into private equity overall? The answer is, trying to pick your time in private equity is a hard thing to do. You're going to be investing over time and creating liquidity over time. Timing the market is a challenge, but broadly speaking, when there's uncertainty in the market and there's more fear than greed, that's usually a good time to be deploying capital. I think it's an opportunistic time and a structure that makes sense.

Anu Rajakumar: Yes, absolutely. Timing the market for anyone is a very challenging game to play, but I think that's a great point. Final question for you, David, as we look ahead to, let's say, the next five years, I know there's uncertainty in the short term, but let's look a little bit further out. What are some key trends that you believe will shape private equity?

David Stonberg: I think there's some megatrends. I don't know if it's five years or eight years. One of the megatrends you just mentioned which is who's investing. You're seeing growth in assets come from different segments of the market from where it was historically. Whether it be the individual investor as compared with the institutional or geographically. You're seeing a, "Is it going to be DC plans?"

You're seeing the inclusion and introduction of private equity into places where it wasn't before. Who's investing it? That's a megatrend. Another megatrend that you're starting to see, which you really didn't see in any meaningful way in the first 40 years of the evolution of the private equity industry, is consolidation. It's part and parcel with what I'll call institutionalization of private equity.

As you're going after new market segments institutionalizing, you're also seeing M&A activity within the world of private equity, and all of that ties together. One of the outputs of that is that you'll also see somewhat of a bifurcation between the less institutionalized organizations and private equity managers who are becoming 'niche-ier' here and leaner and are leaning into their strengths.

We're seeing lots of interesting activity across all areas of the industry. It's so fun to watch for these private equity firms who are doing this, which is—what's the expression?—take your time, hurry up, right?

Anu Rajakumar: [laughs] Yes.

David Stonberg: You're seeing that across the industry, which is hurry up in terms of leaning to your strengths. How do we deliver for our investors? How do we deliver for our investors? How do we deliver for our investors?

Anu Rajakumar: No, those are some great points. David, I can't let you go without a quick bonus question. You've been a private equity investor for many years. As you reflect on your professional journey, I'd love to know what advice you would give to a young person beginning a career in private equity today.

David Stonberg: De facto, on your questions, you're saying I'm not a young person.

Anu Rajakumar: I said nothing, but sure [laughs].

David Stonberg: All right.

Anu Rajakumar: A well-experienced and wise person [laughs].

David Stonberg: I think, broadly speaking, the advice for someone entering private equity is probably not any different from, you want to enter the field of medicine, you want to enter the field of law, you want to become an author. Be curious. Hold yourself to high standards, high integrity. Try and surround yourself with and be associated with people who do those things as well.

Keep your eye open to how things are evolving and changing. Where opportunity is today may be very, very different from where it is five years from now. Just be aware, open your eyes, be sensitive to that, and importantly, have fun along the way.

Anu Rajakumar: That is wonderful way to end our episode, and thank you for sharing those words of wisdom. In today's podcast, we explored lots of interesting topics. To recap a few that we discussed, the impact of tariffs on the private equity asset class, challenges posed by economic uncertainty and limited liquidity, and importantly, how these factors really influenced distributions, exits valuations.

David, you also shared where you believe the opportunities lie, particularly for investors able to provide liquidity, as we discussed. We also highlighted innovations like evergreen funds and making private equity accessible to a wider range of investors. As a reminder, we did allude to this in the episode, David's team did publish a paper recently titled Potential Impact of US tariffs: Private Equity Manager Perspectives, which you can find on nb.com along with the private markets team's recently published Outlook as well. With that, we will wrap this episode. David, thank you again for being here.

David Stonberg: My pleasure. Thank you for having me.

Anu Rajakumar: To our listeners, if you've enjoyed what you've heard today on Disruptive Forces, you can subscribe to the show from wherever you listen to your podcasts, or you can visit our website at nb.com/disruptiveforces, where you can find previous episodes as well as more information about our firm and offerings.

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