A new report from eFront, the leading financial software and solutions provider dedicated to Alternative Investments, shows that private equity holding periods extended in 2020 to a record 5.4 years on average, at the same time as returns dipped.
The data also showed that investments held for longer periods tend to produce higher returns – though this was not the case in 2020.
Holding periods in private equity have increased significantly since 2010, rising from an average of 3.8 years to 5.4 years.
Returns generally rise as holding periods increase, with companies held for less than two years on average delivering less than a 2x multiple on invested capital (MoIC) gross of fees.
The average MoIC increases with a holding period of up to five years and then it stabilises around 2.5x, before reaching a maximum value of above 2.6x for deals held between 9 and 10 years.
Potentially as a result of the pandemic, private equity-backed companies sold during 2020 were held longer in portfolios relative to the historical average.
While average MoIC for investments exited in 2020 fell across most industry sectors, this was not true of IT deals, which achieved an average MoIC of 4x, or Telecom deals, with an average MoIC of 3.5x.
Historical analysis of the holding periods in private equity clearly shows a steady increase over the past 10 years. In the period around the Global Financial Crisis, the average holding period was around 4 years. Since then, private equity funds have held their portfolio assets over a longer time, reaching the maximum in 2019, with a three-year average holding time of 5.4 years.
The increasing holding period does not necessarily reflect a worsening exit climate for private equity-backed companies. Relatively new long-term fund strategies with holding periods of 10, 15 or even 20 years have yet to effectuate the exits for their portfolio companies, but the historical evidence of performance must have provided a proof of concept supporting this private equity sub-strategy.
Another competing explanation is that those fund managers who hold high-quality companies in their portfolios choose to execute dividend recapitalisations and hold on to these companies with further potential to grow.
Deciding to sell a portfolio company undoubtedly involves market timing considerations. Besides the evolving exit market conditions, the question remains if a long holding period plays a role in a deal’s performance. The average multiple of invested capital is showing an interesting pattern.
Holding a company for less than two years will on average deliver less than a 2x multiple on invested capital (MoIC), gross of fees. The average MoIC increases with a holding period of up to five years and then it stabilises around 2.5x.
After eight years of holding period, it starts increasing again and reaches a maximum value of 2.6x gross of fees for deals held between nine and 10 years. It is important to note that there is no causal relationship between the holding period and the subsequent performance for this subset of deals that produce maximum money multiple (the subset comprises only 4 per cent of the total number of deals in the eFront Insight dataset).
Private equity-backed companies that were sold during 2020 were held longer in portfolios relative to the historical average across most industry sectors. The only exceptions were the Materials and Consumer Staples industry sectors.
Interestingly, the industry sectors that experienced the largest positive deviations in holding period relative to the historical average, such as IT, Health Care and Consumer Discretionary, were also overrepresented in the total number of exits that were realised during 2020 (Figure 4). The Industrials sector suffered the largest reduction in its overall representation among the total deals realised during 2020.
The remote nature of 2020 everyday life gave rise to high levels of IT and Telecommunication Services industry deal valuations (Figure 5). While average MoIC for investments exited in 2020 fell across most industry sectors, this was not true of IT deals, which achieved an average MoIC of 4x, or Telecom deals, with an average MoIC of 3.5x. The sharpest drop in realised performance was recorded for private equity-backed companies operating in Materials and Utilities industries.
Melissa Ferraz, Global Head of eFront Insight at BlackRock, says: “A detailed eFront Insight portfolio look-through dataset allowed us to analyse historical data over the past 15 years of exits to understand the evolution of holding periods and disruptions the pandemic brought into the private equity deal market. With only a few exceptions, the holding period for deals exited during 2020 was longer than the historical average across all industry sectors. Simultaneously, the past year also saw lower performance for those deals relative to the historical benchmark.”
“If there was ever a time when the speed at which fund managers were able to increase the value of the portfolio companies and sell them back to the market was the distinguishing manager selection criterion this was the year. Investor focus is now shifting more in direction of managers’ ability to source high quality deals with high profit margins and predictable cash-flows that will ultimately deliver exceptional returns.”