Cambridge Associates’ Andrea Auerbach: Rate cuts in 2024 may break the transaction logjam and spur activity

'Much like covid variants, 2023’s challenges will evolve and expand as we head into 2024, and some might even abate.'

For thoughts on what’s ahead for GPs and LPs in 2024, affiliate title PE Hub turned to Andrea Auerbach, who is a well-known voice in the private equity industry. Auerbach’s career at the Boston-based investment firm Cambridge Associates spans more than two decades. As the head of global private investments and a partner, Auerbach leads a 50-person team sourcing and underwriting private equity, growth equity, distressed and venture capital funds, as well as direct, co-investment and secondary investment opportunities. The interview with Auerbach is part of PE Hub’s ongoing series of Q&As with private equity thought leaders.

What were the biggest challenges for private equity dealmakers in 2023, and how do you expect the challenges to evolve in 2024?

The biggest challenges? Rising interest rates, which began their climb in 2022, really ‘stuck the landing’ in the private markets in 2023.

From the start, GPs could not employ leverage at will in 2023 as interest costs had more than doubled, helping drive down transaction volumes both for platforms and for add-ons. Using historical debt level assumptions – but at the increased cost – simply would not pencil out to the same return outcome, so either valuations had to fall, or equity contributions had to rise in order to get a deal done this year, adding new challenges. Market participants were not yet on the same page, which resulted in what seemed to be a near standstill, also contributing to the much slower transaction activity.

The reduced transaction volume also meant fewer exits for PE-backed companies, contributing to less distributions for LPs. Increased interest costs also affected GPs’ ability to pursue leveraged recapitalisations, which would have been another way to return capital to LPs. In fact, our analysis indicates 2023 will likely be the worst or second worst year for private equity distributions in 25 years, accounting for market size. While private equity distributions are not pre-ordained, in an established well-diversified LP portfolio they can be expected. The distribution drought forced some LPs to generate necessary liquidity by other means, further constraining those programmes and adding another challenge to the 2023 pile. It was no surprise that the secondaries market was hopping as a result.

From the LP perspective, receiving a reduced number of distributions could not have come at a worse time. Amid volatile public markets in 2022, private investment programmes experienced whiplash, starting with a negative denominator problem that often led to an overallocation, which resulted in many pulling back commitments to PE and VC heading into 2023. That in turn negatively impacted the fundraising environment this year.

Also from the LP perspective, as private market valuations continued to adjust (mostly) downward in 2023, the public markets bounced back, with one-year returns significantly higher than one-year returns for private markets. While private equity is clearly not a one-year investment strategy, for programmes that are debating increasing or maintaining their exposure to the asset class, recent public market returns, however concentrated their drivers may be, aren’t helping!

Much like covid variants, 2023’s challenges will evolve and expand as we head into 2024, and some might even abate. Some of the levers pulled by GPs in 2023 to combat inflation and the impact of higher interest costs, including raising prices where possible and focusing on increasing profitability, may be approaching their limits, requiring digging deeper for effective solutions. That said, the possibility of rate cuts in 2024 may well break the transaction logjam and spur activity on multiple fronts.

What’s your overall private equity dealmaking outlook for 2024?

2024 should be a more active year than 2023 for private equity across the board.

Any thoughts on private credit?

Elevated interest rates drew investor attention back to private credit, and private credit was more than ready for its spotlight. But how the story evolves will be something to watch.

Will secondaries and continuation vehicles continue to be attractive to PE firms?

PE firms continue to view continuation vehicles as an attractive way to hit the reset button on certain assets in their funds. LPs are more circumspect and base their participation on the assets selected for inclusion and the vehicles’ terms and alignment – after all, the devil is in the details. CVs are a way to generate LP distributions, so from that perspective, attractive to both GPs and LPs.

Secondary deal volume has been elevated for several years, considerably supported by the rise in GP-led secondaries and more recently by LPs seeking liquidity. The changing valuation environment created more favourable buying opportunities for the prepared secondary investor and that is expected to persist in pockets throughout 2024.

Which sectors do you expect will see the most private equity dealmaking activity in 2024?

If 2023 trends were to continue, the technology and industrial sectors will dominate dealmaking activity in 2024. Technology is not particularly surprising, given it has long held the top spot by a wide margin. Technology continues to permeate all corners of the PE industry, so while tech-focused firms continue to be active, we expect to see more multi-industry firms pursuing tech or tech-enabled investments within their sectors of expertise.

Industrials may be a bit of a surprise but also has some – no pun intended – industrial logic to it, as these companies may have more longstanding and defensible business models than those found in other sectors, with a clearer valuation picture in a private market context. Underwriting improvements to industrial businesses can also be quite tangible to a GP with applicable skill sets, perhaps making them more transactable in the current environment.

The other two sectors that often vie or tie for third are healthcare and consumer, and I have to give the edge to healthcare, at least from a private equity perspective, because it has proven to be resilient, generating stable returns over long periods of time, making it an attractive place to invest.

What are you most looking forward to in 2024?

At Cambridge Associates we’re always exploring potential sources of compelling private equity returns.

Every year there is a constant stream of new funds, co-investment and secondary opportunities, and further evolution of PE strategies – 2024 will be no exception and may well be a banner year. Time will tell.

I’m also looking forward to gaining another year of performance information on investments made during (and leading up to) the 2021 market peak, because the more LPs learn about where the value is building (or not) in that cohort of funds and investments, the more we will know which GPs invested well (or not) in that moment and can allocate capital accordingly. Even with potentially reduced rates in 2024, delivering compelling returns on zero interest rate policy-era buyouts is still going to take some effort.