For institutional investors, distributions are an important part of managing a private equity program. Capital returned through company sales, recapitalizations, public offerings, and other transactions can help fund future commitments, support broader portfolio liquidity, and keep private market allocations closer to their long-term targets.
In recent years, however, distributions have remained below the levels many investors anticipated. Exit activity has slowed, the market for initial public offerings has been selective, and some mature funds have held investments for longer than originally expected.
What makes the current period particularly notable is that limited private equity liquidity has persisted despite relatively resilient economic conditions and a recovery in public equity markets following the declines of 2022. While conditions differ across managers, strategies, and portfolio companies, the broader distribution environment has not recovered as quickly as some market participants expected.
In a recent conversation, Meketa’s Luke Riela discussed several factors that may be contributing to the slowdown, how the current period differs from prior market cycles, and the considerations institutional investors may wish to incorporate into their private equity planning.
A Distribution Cycle That Has Differed from Prior Periods
Private equity distributions have declined during previous periods of market stress. During the dot-com downturn and the Global Financial Crisis, weaker economic conditions and falling public market valuations contributed to reduced transaction activity. In both cases, it took time for the public and private market exit environments to recover.
At the beginning of 2022, the market appeared to be following a broadly similar pattern. Public equity markets declined, expectations for an economic slowdown increased, and private equity distributions began to fall.
The subsequent environment developed differently. The anticipated recession did not occur during that period, and public markets recovered meaningfully beginning in 2023. Private equity distributions, however, remained constrained.
This divergence suggests that the current slowdown may not be attributable to a single factor. Instead, it appears to reflect a combination of higher financing costs, differences between buyer and seller valuation expectations, the level of unrealized value within private equity portfolios, and longer-term changes in the private markets ecosystem.
The Effect of Higher Interest Rates
The increase in interest rates has been an important factor affecting private equity transaction activity. The Federal Reserve’s tightening cycle raised borrowing costs and altered the economics of many leveraged transactions.
For prospective buyers, higher debt costs may reduce the price they are willing or able to pay while still seeking to achieve their investment objectives. Buyers may need to assume greater operational improvement, accept lower potential returns, contribute more equity, or negotiate a lower purchase price.
Sellers, meanwhile, may be reluctant to transact at those lower prices, particularly when portfolio companies continue to demonstrate stable or improving operating performance. In some cases, general partners may determine that holding an asset for longer is preferable to selling at a valuation below their assessment of its long-term value.
The resulting difference between buyer and seller expectations has contributed to slower transaction activity. Potential exits may be postponed while sponsors wait for improved financing conditions, stronger operating results, or greater alignment around valuation.
The size of private equity portfolios has also influenced reported distribution rates. Strong performance in 2020 and 2021 increased unrealized portfolio values for many investors. When public markets declined in 2022, private equity valuations generally adjusted more gradually. As a result, distributions declined relative to a comparatively large base of unrealized value.
Considerations for Institutional Portfolios
The distribution slowdown has created several challenges for institutional investors.
Many allocators entered this period with private equity exposures near or above their strategic targets. Strong private equity performance in 2020 and 2021 increased the value of private market holdings. When public equity and fixed income markets declined in 2022, total portfolio values fell while reported private equity values generally changed more slowly. This increased private equity allocation percentages for some investors.
Subsequent public market performance and more moderate private equity returns may have reduced some of that pressure. However, distributions from mature funds have not always occurred at the levels incorporated into prior pacing assumptions. Investors that expected those proceeds to fund capital calls or reduce private equity exposure may have needed to revise their plans.
The environment has also placed greater emphasis on the composition of reported private equity returns. Internal rates of return and total value to paid-in capital remain relevant measures, but both can include substantial unrealized value.
Distributions to paid-in capital, or DPI, provides a measure of the capital that has been returned to investors. DPI does not, by itself, determine the quality of a manager or investment program. A lower DPI may reflect a younger portfolio, a strategy with longer expected holding periods, or market conditions that have delayed exits. Nevertheless, examining DPI alongside other performance, valuation, and portfolio measures can help investors better understand the source and realization of reported returns.
Maintaining Perspective on Vintage-Year Exposure
Limited liquidity and above-target allocations may lead some institutions to reduce the pace of new commitments. The appropriate response will depend on each investor’s objectives, governance structure, liquidity needs, existing exposures, and tolerance for private market risk.
Private equity performance has historically varied across vintage years, and periods of high fundraising activity have not always corresponded with the strongest subsequent returns. However, historical relationships do not ensure that future vintage years will follow the same pattern.
Reducing or pausing commitments may help address near-term liquidity or allocation concerns, but it can also create gaps in vintage-year exposure. A portfolio concentrated in a narrow group of years may be more sensitive to the market conditions that affected investments made during that period.
Maintaining a relatively consistent commitment program may support diversification across market environments, but it does not eliminate investment risk or guarantee stronger results. Investors should evaluate commitment pacing in the context of their total portfolio, projected cash flows, manager relationships, and long-term private equity objectives.
Reviewing Pacing and Liquidity Assumptions
The current environment may provide investors with an opportunity to review the assumptions used in private equity pacing models.
If holding periods and fund lives continue to extend, historical distribution assumptions may overstate the amount or timing of future cash flows. A model that anticipates distributions arriving sooner than they ultimately do could lead an investor to make commitments that place greater pressure on portfolio liquidity.
This does not necessarily mean that all historical assumptions are no longer useful. Rather, investors may benefit from comparing those assumptions with the experience of their own portfolios and the characteristics of their current manager and strategy exposures.
Stress testing can also help illustrate how a program might respond under different conditions. Scenarios could include continued limited exit activity, longer holding periods, lower public market values, slower fundraising, changes in capital-call activity, or an economic downturn.
These exercises cannot predict future outcomes, but they may help investors identify potential liquidity constraints and consider possible responses before those constraints become more pronounced.
The Evolving Role of Secondaries and Continuation Vehicles
Secondary markets are playing a larger role in private equity portfolio management. Institutional investors may use secondary transactions to generate liquidity, reduce selected exposures, manage vintage-year concentrations, or reposition portfolios.
The suitability of a secondary sale depends on several factors, including the quality of the underlying assets, the price available in the market, the investor’s liquidity needs, and the potential value of continuing to hold the interests. Secondary transactions may provide liquidity, but they can also require the seller to accept a discount to reported net asset value.
Continuation vehicles have also become a more common part of the private equity market. In these transactions, a general partner may transfer one or more assets from an existing fund into a new vehicle. Existing limited partners may be offered the option to receive liquidity, continue their exposure, or pursue a combination of the two.
These transactions can provide additional time and capital for a sponsor to execute its value-creation plan. They can also create valuation, governance, conflict-of-interest, and fee considerations that require careful review.
As these opportunities become more frequent, investors may benefit from establishing a consistent process for assessing the transaction terms, the underlying assets, the sponsor’s rationale, the available alternatives, and the implications for the broader portfolio.
Is this a temporary disruption or the new operating environment for private equity?
The current distribution environment appears to reflect both cyclical market conditions and longer-term changes in private markets.
Higher financing costs have affected transaction activity and may improve if interest rates decline or lending conditions become more supportive. A broader recovery in mergers and acquisitions or public offerings could also contribute to increased distributions.
At the same time, companies have greater access to private financing than they did in prior decades. Private equity firms also have more tools available to extend ownership or provide partial liquidity. These developments may continue to influence holding periods even if the broader exit environment improves.
For institutional investors, the implications will differ based on portfolio construction, manager selection, liquidity requirements, and investment objectives. The current environment may warrant updated pacing assumptions, closer analysis of realized and unrealized returns, and greater attention to the range of tools available for managing private market exposure.
Private equity distributions are likely to remain uneven across managers and strategies. Understanding the underlying sources of liquidity, as well as the assumptions supporting future cash-flow expectations, may help investors make more informed decisions as the market continues to evolve.
Watch the Full Conversation
To hear Luke Riela’s full discussion of private equity distributions, pacing, secondary markets, and the changing exit environment, watch the complete interview below.
This document is for general information and educational purposes only, and must not be considered investment advice or a recommendation that the reader is to engage in, or refrain from taking, a particular investment related course of action. Any such advice or recommendation must be tailored to your situation and objectives. You should consult all available information, investment, legal, tax and accounting professionals, before making or executing any investment strategy. You must exercise your own independent judgment when making any investment decision.
All information contained in this document is provided “as is,” without any representations or warranties of any kind. We disclaim all express and implied warranties including those with respect to accuracy, completeness, timeliness, or fitness for a particular purpose. We assume no responsibility for any losses, whether direct, indirect, special or consequential, which arise out of the use of this presentation.
All investments involve risk. There can be no guarantee that the strategies, tactics, and methods discussed in this document will be successful.
Data contained in this document may be obtained from a variety of sources and may be subject to change. We disclaim any and all liability for such data, including without limitation, any express or implied representations or warranties for information or errors contained in, or omissions from, the information. We shall not be liable for any loss or liability suffered by you resulting from the provision to you of such data or your use or reliance in any way thereon.
Nothing in this document should be interpreted to state or imply that past results are an indication of future performance. Investing involves substantial risk. It is highly unlikely that the past will repeat itself. Selecting an advisor, fund, or strategy based solely on past returns is a poor investment strategy. Past performance does not guarantee future results.