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Tariff uncertainty in focus

Private equity investors have had a busy 1H. The US administration’s 2 April tariff announcement took investors by surprise, leading to a global equity markets selloff as trade war fears intensified. The subsequent rollback of the tariff announcement also surprised equity markets, which rallied significantly on news of a pause. As with the 2022 tech-led selloff, private equity tends to lag the public markets, but is not immune from a turbulent market.

The most immediate effects are to portfolio valuations, which are linked directly and indirectly to public comparables; these have, in hindsight, been modest since equities recovered quickly. Second-order impacts relate to forward expectations, including liquidity: public markets are a key exit path for privately held companies, and hopes of an active 2025 M&A market have effectively been dashed by the market uncertainty (though were already looking likely to underperform optimistic expectations going into the year).

This will exacerbate the cycle of longer holding periods for private companies, fewer distributions to investors, and a poor fundraising environment. Uncertainty has also played a role in the US central bank’s decision to keep rates unchanged at elevated levels, which is less favorable for creating private equity returns through borrowing.

Fundraising is especially challenging for new managers because smaller investor budgets are often allocated to
re-ups with existing managers and a general risk-off sentiment. This caution may not be fully warranted in an asset class that typically has a 5-10 year return horizon.

In terms of investment strategy, we believe the current market favors larger, market-leading companies which are exposed primarily to their respective domestic markets.

The sponsors best positioned to succeed today are those employing modest leverage, driving operational improvement, and those who have a clear sense of risks and opportunities within their current portfolios. Dry powder also helps – both to support existing portfolios and capitalize on emerging opportunities. While cautious on the macro, which includes a weakening US consumer, uncertain times have also produced some of the strongest vintages of private equity funds. Today’s market does present risk, but also opportunity.

Venture capital

While facing plenty of uncertainty of their own, venture backed companies are largely insulated from tariff pressures, as they tend to produce few tariff-exposed products. The negative IPO sentiment does hurt late-stage companies with public aspirations, but the outlook has been dim for a while, and the investment cycle has become so long that fewer companies are affected than would have been in the past.

Investors are now ‘in it for the long haul’ and looking toward the next golden era of venture capital, with most investors focused on AI-related investments. These hold plenty of promise, but are in early innings and will probably take years to show true results.

Within AI, investments which enhance application and broaden economic potential appear better positioned than model development and those focused on interface/user adoption (following recent trends that have abandoned unprofitable user growth).

The dynamics of the post-2021 venture capital hangover are still slowly resolving, with gains largely remaining on paper, exits being rare, and distributions even rarer. Selective investment behind top funds and the most promising up-and-comers continues to be the strategy for most investors.

Figure 1: Venture capital quarterly fund returns (%)

Figure 2: Private equity quarterly fund returns (%)