Hard Evidence Proves Geopolitics Really Does Affect Private Equity Returns

This blog is a summary of IPEM's exclusive webinar series for LPs in partnership with Gottschalg Analytics, exploring critical topics for LPs in today's private equity market.

New analysis has established the true link between what geopolitical volatility really means for private equity performance.

Economic Policy Uncertainty (EPU) has become a significant factor influencing private equity returns, according to Oliver Gottschalg. Recent research highlights the intricate relationship between EPU and private equity performance, offering insights into how fund managers can navigate these uncertain times effectively.

What is Economic Policy Uncertainty?

Economic policy uncertainty is characterised by unpredictable changes in government policies that can affect economic conditions. This uncertainty can influence investment decisions, market dynamics, and ultimately, the performance of private equity deals.

Why does it matter to investors?

Positive impact at entry: Deals initiated during high EPU periods tend to yield better performance outcomes. This is attributed to lower entry prices, as uncertainty often leads to reduced valuations, allowing private equity firms to acquire assets at more attractive prices.

Negative impact over time: An increase in EPU during the holding period of a deal generally results in poorer performance. This is due to the challenges in managing assets under uncertain conditions, which can lead to prolonged holding periods and reduced returns.

Skill of fund managers: The ability of fund managers to navigate EPU is crucial. Those with a proven track record of managing deals in high EPU environments tend to outperform their peers. This skill is not only about managing uncertainty but also about capitalising on the opportunities it presents.

How do private equity investors respond?

Investors should consider the following:

Assessing Fund Manager Skill: Evaluate the historical performance of fund managers during periods of high EPU. This can provide insights into their ability to manage uncertainty and generate strong returns.

Portfolio Adjustments: While shifting portfolios to focus on managers with high EPU skills can be challenging, co-investment opportunities can be prioritised with those managers who have demonstrated this capability.

Sector Considerations: Although sector specialisation generally leads to better performance, during high EPU times, the skill of the fund manager is a more significant determinant of success than the sector itself.