Chart of the Week (July 12) - Spread Between Carrying and Exit Multiples

For this week’s Arctos Insights chart of the week, we highlight a valuation divergence that has emerged in the private markets and its subsequent effects on distribution yields, as highlighted in our recent Q2 2024 Keystone Market Update.

During the post-GFC bull market, GPs tended to mark their underlying assets conservatively, with ~70% of exits occurring at a higher valuation than the last quarterly mark (source: Bain). One way to illustrate this is to look at the average carrying multiple of PE-backed assets relative to average exit multiples over time. Historically, during periods when the average exit multiple was higher than the average carrying multiple, distribution yields were, unsurprisingly, robust, as GPs were exiting at a premium to their mark (on average).

In 2022, for the first time in over a decade, the delta between carrying EBITDA multiples and exit EBITDA multiples inverted, and the spread widened further in 2023. On average, actual transactions are occurring at more than a turn lower than the average holding multiples for unrealized assets.

Historically, managers have been reluctant to mark down investments, instead opting for a “wait it out” approach to downturns and challenging exit environments. As a result, NAV tends to be relatively sticky, leading to a lag between private equity NAVs and public markets. As discussed in our market update, we believe this lag has led to a meaningful NAV overhang that is creating a “numerator effect” on LP allocations to private equity, further straining an already challenging fundraising environment.