A reasonable observation about the next decade of private equity: the returns that justified the asset class through its first forty years will be more difficult to repeat, and the firms that recognise this earliest will define the firms that endure.
The mechanics that drove private equity returns from the late 1980s through the 2010s — financial leverage, multiple expansion, the prevailing decline in the cost of capital, and the disciplined application of conventional levers to under-managed corporate assets — are exhausted, repriced, or both. None of this is a forecast. It is description.
What this means is plainly stated. The portion of historical returns attributable to structural tailwinds is unlikely to repeat. The portion attributable to operating improvement remains available, but only to firms whose operating capability is real, not stated. The portion attributable to thematic selection — identifying durable secular shifts and underwriting them with patient capital — remains substantial, but the analytical bar has risen materially.
We hold three positions on the future of the asset class, offered here without ornament.
“The buyer who can change the trajectory of a business will outperform the buyer whose principal advantage was the cost of capital.”
(One) The advantage will accrue to operators, not arbitrageurs. The buyer who can change the trajectory of a business through governance and operating intervention will outperform the buyer whose principal advantage was the cost of capital. This is not a new claim. It is, however, a now-binding one. A buyer who depends on multiple expansion to justify a thesis is exposed to a market over which the buyer has no control.
(Two) The dispersion between firms will widen. The conditions of the last decade compressed outcomes — many strategies that should not have produced top-quartile returns did, because the tide accommodated. As the tide neutralises, the dispersion between disciplined and undisciplined practitioners will reveal itself clearly. We expect this revelation to be uncomfortable for parts of the industry.
(Three) Liquidity premia will reprice. The thesis that private markets justified their illiquidity through superior fundamental returns has been tested by an environment in which public-market liquidity, dividends, and selective exposure produced competitive outcomes. We do not predict the resolution of this debate. We observe that the bar for compensating partners for illiquidity is now higher than it was a decade ago, and the work required to meet that bar is more substantial.
These observations have direct implications for how we operate.
“Competitive auctions, by their architecture, transfer surplus from buyer to seller.”
We have de-emphasised auction processes. Competitive auctions, by their architecture, transfer surplus from buyer to seller. They are appropriate for sellers; they are unflattering for disciplined buyers. We participate in them selectively and infrequently, and only when the operating thesis is unusually clear.
We have lengthened our underwriting horizons. The base-case period over which we now evaluate an investment has moved from five-to-seven years to seven-to-ten, with an explicit consideration of how the business performs across more than one cycle. This is not a forecast that the next cycle will be shorter or longer than the last. It is an acknowledgement that any thesis dependent on a benign multi-year window for monetisation is, by construction, fragile.
We have widened our remit. Strict adherence to a buyout playbook — leveraged acquisition, three-to-five-year operating intervention, exit to a strategic or a financial buyer — has been the default mode of the industry. We continue to do this work where it remains the correct vehicle. We also, increasingly, hold positions as long as the business merits our capital, and resist the assumption that every investment terminates in a sale.
A practical caution. None of this is a doctrine. We are not asserting that the playbook of the last forty years should be discarded; we are asserting that its limits have become visible. The institutions that succeed in the next decade will be those that retained the disciplines of the old model — patient diligence, governance rigour, financial conservatism — while shedding the assumptions that those disciplines, by themselves, would suffice.
A closing observation. The most common error of our industry, in the present moment, is to mistake exhaustion for crisis. The conditions that produced the last cycle's returns are exhausted; the asset class is not in crisis. There is more capital chasing fewer truly good businesses than there was a decade ago, and the returns to discipline have widened, not narrowed.
The institutions that will look strongest from the vantage of 2035 are the ones whose answers to these questions are already settled. Ours are.
— Quantum US Capital Partners LLC