Data suggests a slight pick-up in exit activity in private markets, which could mark the beginning of a recovery for oversold private equity investment companies, according to a research report from Jefferies. 

Private equity trusts have not had it easy in the growth selloff and the already hefty discounts widened further this year, with the Numis PE – Direct sector, excluding private equity giant 3i (III ), sitting at an average discount of 26.7%.

Sentiment towards the sector is slowly turning and could be given a further boost by the green shoots of exit activity that are being witnessed in private markets, said Jefferies investment companies analyst Matthew Hose.

The exit value of US private equity deals has increased quarter-on-quarter for the first time in 12 months, with private equity buyout valuations on the Russell 2000 Value index up 2.5%. 

Investors are still waiting for clearer signs of an uptick in exits given the ‘current stand-off between buyers and sellers over valuations’ that have plagued markets and seen investors grow fearful of funds writing down their assets.

Hose pointed to a study by Neuberger Berman last year that analysed ‘distribution patterns’ in the wake of the bursting of the dotcom bubble and the global financial crisis. Distributions refer to the capital payed to investors after a fund manager exits some of their investments. 

‘Although distributions in both periods immediately declined, the subsequent rebound in exits lagged the recovery in public equity markets by only a few quarters, before staging a full recovery,’ he said.

Hose said the third quarter last year presented the ‘trough’ for the equity market, suggesting ‘exit activity will pick up in the next few quarters’.

While the stalemate over valuations may last a while longer, he said a broader recovery in equity market ‘could help buyers gain more confidence, and against this, sellers may need to compromise to return capital back to limited partners in order to support fundraising efforts’.

The maturity-level factor

Not all funds are created equal when it comes to benefiting from exits. He highlighted mid-market investments as they have ‘less reliance on IPOs for exits’ and can acquire debt financing. 

The largest driver of exits is, however, maturity levels and most funds have a maturity ‘sweet spot’ of between four and five years, with only HgCapital (HGT ) having a maturity closer to three years.

The £1.7bn HarbourVest Global Private Equity (HVPE ) and £1.4bn Pantheon International (PIN ) fund are the ‘most mature’ but Hose said this ‘needs to be set against the fact they contain some exposure to venture and growth investments where the exit environment remains ‘highly challenging’.

An uptick in exits will give funds flexibility in capital allocation decisions and there is a ‘clear shareholder impetus towards making share buybacks’.

HVPE announced a £200m share buyback programme this month.

Hose said funds are weighing the longer-term opportunity cost of returning capital versus reinvestment, but buybacks will be a ‘release valve’ to manage excess liquidity that when used is ‘likely to amplify the near-term positive impact on the share price of seeing more exits’.