10.03.25 - Private Equity - waiting for the storm

In recent years, private equity has gained significant traction as an attractive investment option, driven by an extended period of historically low interest rates and subdued returns from traditional asset classes. Initially accessible and favored by institutional investors, private equity has increasingly become accessible to private investors as well, drawn by the potential for higher returns.
Private equity offers distinct characteristics, including: illiquidity, leverage, limited transparency, higher fees, long-term investment horizon, potential of higher returns.
This combination of higher return expectations for investors and attractive fee structures for banks has created a compelling win-win scenario, making private equity an increasingly popular component of diversified investment portfolios.

Markets: Volumes in the private equity market have grown significantly in recent years, driven by strong demand, fueled by the performance and return potential. As a result, private equity firms have raised substantial amounts of capital, creating considerable pressure to identify and pursue attractive new investment opportunities.

My view: I always aim to think ahead and proactively prepare for potential market scenarios. Currently, the market is not yet in panic mode, as illustrated with my last comment on Market Insights “Recession fears”. However, if the current sell-off continues, it could trigger a cascade effect involving stop-limit orders by technical indicators and margin calls, leading to increased downward pressure and possibly leading to a short-term market collapse.

Private investors, particularly those advised by banks, remain significantly invested in the tech sector. Should market sentiment deteriorate further, fear could prompt these investors to reduce exposure to limit losses or secure profits, significantly increasing the supply of shares in the market.

Several factors are converging to create heightened uncertainty, including recent political turmoil and an increasingly unpredictable economic trajectory. Additionally, the market currently has a substantial population of speculators lacking deep market experience, who until now have consistently relied on buying dips. This strategy, effective during recent years, is now failing to yield the same results, with many speculators rapidly exhausting available capital. Consequently, the diminished buying power could substantially reduce market demand.

This scenario, characterized by increased supply and dwindling demand, poses a tangible risk of further stock price declines, potentially escalating into a market crash.

Notably, private equity has yet to experience a genuine financial storm. The brief market downturn during the covid pandemic quickly reversed within a matter of months, and thus does not represent a true crisis scenario. However, the current situation seems fundamentally different. If negative momentum intensifies, the likelihood of a significant market crash grows considerably.

Given private equity's inherent illiquidity, simultaneous investor withdrawals could amplify market stress, potentially leading to systemic consequences like a house of cards collapsing, adversely impacting private equity portfolios and financial institutions alike.

Although this is not yet my primary outlook, it has become a critical scenario I actively consider in my investment decision-making process.

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