Private equity: amid uncertainty, small is beautiful

Nils Rode

Despite rising uncertainty due to major US policy changes, our outlook for private equity remains positive. We are optimistic about small and mid-sized buyouts, early-stage venture capital, and continuation opportunities.

Historically, small and mid-sized buyouts have demonstrated resilience during past crises and typically have less exposure to global trade. Early-stage venture capital is often less correlated with listed markets, and continuation opportunities can perform well when exit markets are subdued. Additionally, current valuations are attractive, following a protracted slowdown in fundraising and deal activity. We recommend that investors remain highly selective and emphasise diversification across strategies and portfolio companies to navigate uncertainties effectively.

US policy changes and uncertainties surrounding AI-driven capital expenditures, as showcased by DeepSeek, have intensified volatility in listed markets. These developments pose significant risks to economic growth, inflation, and interest rates. With this backdrop, investors should focus on private equity strategies that exhibit characteristics such as favourable entry valuations, domestic market exposure and robust downside protection, while offering reduced correlation with public markets and the potential for additional risk premiums. 

US policy changes create uncertainty

Following a three-year slowdown across private markets in terms of fundraising, new deals and exits, private market valuations and yields are generally attractive in both absolute and relative terms. However, risks have increased sharply since the beginning of the year due to the US government’s policy changes and the uncertainties around their implementation and impact. This is most notable in relation to trade tariffs, immigration, ESG considerations, and a more isolationist stance regarding geopolitics and defence.

This has significantly increased volatility in listed markets and heightens near-term risks to economic growth, inflation and interest rates. The global repercussions of US policy changes are also likely to induce industry- and region-specific challenges, further contributing to continued increased volatility.

Question marks around AI related capital expenditures

Meanwhile, the efficiency gains potentially showcased by DeepSeek for generative artificial intelligence (AI) models introduce new uncertainties concerning capital expenditure (capex) and valuations levels of companies benefiting from the AI narrative. 

With careful construction, private equity can enhance portfolio resilience

Private equity generally offers protection against public market volatility and can thrive even amid uncertainty, as we have shown previously. Nevertheless, we find that in the current market environment, some strategies exhibit notably better risk/return profiles than others.

Consequently, we urge investors to be discerning in selecting strategies and investments. Additionally, diversification across strategies is important. We see the most attractive investment opportunities in the current market as being characterised by:

• Balanced capital supply and demand dynamics, leading to favourable entry valuations and yields
• Domestic companies and assets offering some insulation from geopolitical risks and trade conflicts
• Opportunities for additional risk premiums arising from complexity, innovation, transformation, or market inefficiencies
• Robust downside protection through limited leverage or asset backing
• Reduced correlation with listed markets, owing to distinct risk exposures

Small and mid-sized buyouts look especially attractive for multiple reasons

As we have shown previously, over the past 25 years, private equity has thrived during periods of market disruption, achieving twice the outperformance in times of high volatility compared to more stable periods. Importantly, in four of the five major market disruptions within this timeframe, small and mid-sized buyouts were key contributors to private equity’s resilience (see chart above). In 2025, we again expect small and mid-sized buyouts to offer particularly attractive opportunities for enhancing portfolio resilience.

We prefer small to mid-sized buyouts over larger transactions, as they benefit from a favourable capital supply-demand dynamic and face lower competition for a broader range of deals. Additionally, this market segment offers compelling entry points for investment (see chart below), with less reliance on debt financing and significant potential for value creation. Furthermore, small to mid-sized buyouts can grow to become acquisition targets for larger buyout funds, providing an additional exit path.

In the current market context, it is especially beneficial for smaller buyouts that they typically focus on domestic companies, making them less susceptible to trade and geopolitical tensions.

Stable and attractive multiples for small-mid buyout investments

Less competitive small-mid buyout market offers strong potential for outperformance and value creation.

Continuation funds poised to continue strong growth trend

The secondaries market saw a record transaction volume of $160 billion in 2024. Continuation funds remained a key growth area, providing valuable liquidity options to investors and accounting for a record $71 billion in transaction value (see chart below).

Continuation funds are a compelling exit route for portfolio companies, especially small and mid-market firms with significant transformational growth potential. In the short term, this appeal is amplified by current uncertainties that are slowing the recovery of exit markets.

In the long term, considering the ongoing growth of private equity and the trend of companies staying private longer, we project that the continuation fund market segment could reach an annual transaction value of $250 billion within the next decade.

Despite exuberance around AI, innovation dynamics remain attractive

Efficiency gains demonstrated by DeepSeek have sparked concerns about the significant capital expenditure related to AI, contributing to valuation pressures for certain AI companies, particularly in the US. We view these risks as relatively contained for private companies, as venture and growth capital investments typically favour capex-light investments focused on the application layer of the AI stack. Companies leveraging AI models can benefit significantly from the associated efficiency gains.

Moreover, while AI investments reached 15% of global venture investment in 2024, innovation and disruption extend beyond AI, encompassing sectors such as biotech, fintech, climate tech, and deep tech. Accelerating innovation dynamics across various sectors are supported by increased political focus on venture capital as a strategic tool to bolster national competitiveness.

We see significant potential in the recovering biotech sector, which has faced years of risk aversion, and generally find early-stage venture more attractively priced and isolated from current uncertainties than late-stage venture and growth capital.

By Nils Rode, CIO.