The era of ultra-low interest rates, abundant liquidity and easy multiple expansion has ended. Ahead of SuperReturn Europe, Daniel Leith, Head of Private Equity at the Pension Protection Fund, considers whether private equity still merits a significant allocation - and the manager capabilities LPs should prioritise in a more demanding environment.
Key takeaways
- Private equity returns can no longer depend as heavily on cheap debt and multiple expansion, increasing the importance of operational value creation.
- LPs may need to prepare for lower long-term returns and wider performance dispersion across private equity managers.
- Revenue growth, margin expansion, disciplined entry pricing and effective M&A integration will be important manager-selection criteria.
- Private equity retains fundamental structural advantages, but LPs will need to be increasingly selective when making new commitments and recommitments.
The 12-year private equity party
I like to tell our CIO that we could not have started our private equity programme at a better time. It was 2010, immediately after the GFC, and the good times were just getting started.
The party ran pretty much uninterrupted for the next 12 years. Fuelled by ultra-low interest rates, the next dozen years saw strong year-on-year returns, abundant liquidity, with eight of the next 12 years seeing above-average distribution yields, huge growth in fundraising, with annual private equity fundraising expanding by more than six times between 2010 and 2021, and massive expansion across the asset class, with many new entrants and spin-outs.
The party ran pretty much uninterrupted for the next 12 years
Daniel Leith, Head of Private Equity, Pension Protection Fund
The hangover after 2022
When the Federal Reserve started raising interest rates in March 2022, allied with a painful reset in growth equity markets, the party came to an abrupt halt. Indeed, many LPs, particularly those with mature programmes, are still experiencing the hangover.
Ever since, the challenges have been myriad: the cost of debt has effectively doubled; liquidity fell off a cliff and remains nearly 50% below long-term averages; returns have been weak, both on an absolute basis and relative to public markets; fundraising has become much more challenging, except for a small subset of primary managers and secondary funds; the inventory of unrealised portfolio companies has expanded relentlessly and average holding periods have lengthened substantially; and the advent of AI has caused serious dislocation in enterprise software, the largest sector in private equity, with some LPs deeply sceptical about carrying values in this part of their portfolio.
The questions LPs now need to ask
With this as the backdrop, how should LPs think about private equity going forward? Is it still an attractive asset class? Does it still merit a significant allocation within a strategic asset allocation?
What risk premium should LPs be demanding? What GP skill sets should LPs be looking for when committing to new funds? What will happen to so-called zombie managers that struggle to raise capital? Should LPs ramp up their co-investment programmes?
There is unlikely to be a single answer that applies to every institution. However, these questions underline the growing importance of manager selection, disciplined pacing and demonstrable value creation when LPs make new commitments and review existing relationships.
How the private equity return model is changing
Stepping back, it seems reasonable to assume that long-term private equity returns are trending downwards. This is perhaps an inevitable consequence of the huge expansion of the industry, with more and more managers chasing deals, allied with a structurally higher cost of debt.
However, it may also be that the dispersion of returns will widen, with the interquartile range increasing.
Furthermore, some market participants believe that the private equity risk premium has increased and that the components of that premium have changed, with the illiquidity portion declining but the fund-selection and manager-skill elements increasing.
Another thing to consider is that the components of private equity returns have changed: between 2018 and 2021, 40% of private equity value creation came from multiple expansion; today that number is 8%, and LPs should not expect this to change significantly over the medium term.
What LPs should demand from managers
Therefore, it seems clear that LPs must find managers who can relentlessly drive revenue growth and margin expansion, allied with a cast-iron discipline around entry pricing and pacing.
LPs must find managers who can relentlessly drive revenue growth and margin expansion, allied with a cast-iron discipline around entry pricing and pacing.
Daniel Leith, Head of Private Equity, Pension Protection Fund
With this in mind, what skill sets should LPs look for in their managers? We believe they should include the following:
Deep networks: Not just for initial sourcing, but for attracting talent and identifying add-on M&A.
The ability to execute and integrate M&A: Managers need to execute accretive, programmatic and transformative add-on M&A and effectively integrate acquisitions. Based on feedback from management consultants and subsequent owners, many LPs would be surprised by how poorly many GPs integrate add-ons.
The ability to deliver cost take-out: This was largely a lost skill set between 2010 and 2022.
Effective operating partners: They must be able to work productively with portfolio-company management teams.
A willingness to act on underperformance: This includes a bias towards replacing underperforming CEOs and management teams at the earliest opportunity.
Sector specialisation combined with functional expertise: Having a go-to-market function within a value-creation team is useful, but go-to-market is very different in healthcare compared with industrials, for example.
Lasting relationships with corporates: These relationships can provide access to carve-out opportunities and potential exit routes.
Credibility with founders and families: In mid-market private equity, managers need to speak the right language and be perceived as business-builders rather than simply providers of capital.
The ability to optimise exits: Managers should be capable of creating competitive tension within exit processes.
This is not an exhaustive list and, indeed, some LPs might disagree with some of these items. Furthermore, it is highly unlikely that any manager will possess all these skill sets.
Nevertheless, we find that our best managers possess many of them. For that reason, we find this a useful architecture when considering new managers and making recommitment decisions.
Why private equity still earns its place
Despite the challenges, there are reasons to be hopeful.
Private equity retains its fundamental advantages: information asymmetry, better alignment, active ownership, a longer-term perspective and optionality. Furthermore, our own experience of committing capital since 2022 has produced strong returns.
Private equity retains its fundamental advantages: information asymmetry, better alignment, active ownership, a longer-term perspective and optionality.
Daniel Leith, Head of Private Equity, Pension Protection Fund
Perhaps the best way for LPs to think about the current environment is to recognise that the main party is well and truly over and we must now find our way into those quiet, select, largely invitation-only parties that were always going on in the background.
The main party is well and truly over and we must now find our way into those quiet, select, largely invitation-only parties that were always going on in the background
Daniel Leith, Head of Private Equity, Pension Protection Fund
Want to hear more? SuperReturn Europe takes place from 3–6 November 2026 at Hotel Okura Amsterdam. Join Daniel and other LPs, GPs and private markets leaders for four days of insight, discussion and networking.