Has Liquidity Dried Up in Private Equity?

Given the uncertainties in how inflation and the economy will play out in the coming months, we consider three hypothetical macroeconomic scenarios.

• Positive supply shock: We assume that supply-chain bottlenecks, which had contributed to the past year's high inflation, lessen. As a result, inflation is dampened moderately. In addition, the Federal Reserve slows its hikes in interest rates, and consumer sentiment climbs. Under this scenario, equity markets are assumed to regain some ground in the near term.
• Soft landing: The Fed lowers inflation without causing a severe recession, although economic growth slows in the near term. Long-term growth stays intact. Equity returns decline below the baseline in the near term.
• Stagnant long-run growth: Trend growth slows, moving the economy to a lower-growth path that persists for many years. Under this scenario, the equity market will retreat further.

Contributions to and distributions from private-equity buyout funds have shown positive sensitivity to lagged returns in the public-equity market historically.² Consistent with this, through the second quarter of 2022 both capital calls and distributions from private-equity funds slowed,³ as the public market sharply sold off. Although equities have moved up modestly since then, the public-equity market is still down sharply for the year through Nov. 16. As a result, the slowdown in private-equity capital calls and distributions could continue into 2023. Under all three assumed macroeconomic scenarios, use of historical sensitivities suggests that contributions could be lower in 2023 than their historical levels from 2016 to 2020 (see the left panel of exhibit below).⁴ This holds both for funds launched in 2022 and for funds to be launched in 2023. As a result of the diminishing availability of viable buyout deals due to high borrowing costs, contributions drop by as much as 35% in the scenario of stagnant long-run growth. Use of historical sensitivities also suggests that distributions on older vintages could be lower in 2023 than the historical average under all three scenarios (see the right panel of the exhibit below). Diminished valuations may cause managers of private funds to delay selling portfolio companies or force them to exit at lower prices, driving distribution reductions in 2023. Scenario distributions from vintage 2014 and 2015 drop by 20% to 50%.

Changes to the outlook of private-equity cash flows could have several implications for investors. First, some investors may have to adjust how they fund capital calls. Historically, investors with a mature private-asset program have been able to fund capital calls of young vintages entirely with distributions from old vintages. If distributions slow down more than contributions, that will be much harder. Short of private-fund distributions, investors may need to raise liquidity by selling assets from the public book at unfavorable valuations.

Second, confronting high funding costs, investors may need to lower their private-equity exposure either with a sale of their fund stake in the secondary market or by cutting back on new private-equity commitments. Private-equity cash flows have slowed down in the wake of swooning equity markets. How much further cash flows and funding ratios may decline depends on how inflation and the economy will unfold. Investors may wish to assess their total plan liquidity management and private-equity commitments with these connections in mind.The authors would like to thank Luis O'Shea at Burgiss and Will Baker for their contributions to this post.