Welcome to the inaugural weekly edition of Testing the Thesis.
Slightly longer than I intend future weekly editions to be, this article takes a closer look at vintage year 2021 to see whether it deserves its poor reputation.
In terms of private markets news, here are a couple of news stories that caught my eye over the last week:
The FT has identified “Technology Investors” as the new aggressive bidders for target companies. The ability of such groups, including Sequence Holdings, General Catalyst and Thrive Holdings to add operational value through the deployment of AI is the reported competitive edge. An interesting trend to watch.
Per Reuters, Qatar's sovereign wealth fund QIA and JP Morgan Asset Management will be launching a USD 20 billion strategic partnership comprised of a USD 15 billion global equities mandate and USD 5 billion of senior financing for middle-market firms. The interesting aspect of this, for me, is that it is a large bank providing exposure to what is, in essence, private debt – an asset class born out of the retreat of the banking system.
Did private markets’ current woes originate in one poor vintage?
Private credit defaults, frozen exit markets and underperforming PE funds have all featured heavily in the financial press in recent months. Some of this is surely overblown, as I have often argued in relation to Direct Lending default rates. Nonetheless, it is also clear that times are not quite as easy for private markets fund managers as they were during the era of ultra-low interest rates.
Fortunately, some nuance has started to creep into the popular reporting. Specifically, the focus has now shifted to an examination of the sources of the perceived underperformance, and exuberance during the boom years is taking much of the blame; 2021 is often singled-out.
The logic is simple: interest rates in Western economies were at or near zero, and dry powder in private equity and private credit funds had reached new highs. What’s more, by this point private markets in both the US and Europe had already achieved a size and level of sophistication that allowed for widespread standardization. This proved to be a perfect cocktail for high levels of competition for deals and, so the argument goes, sloppy underwriting.
Fast forward to 2026, and these deals are getting to the end of the typical private equity holding period, and GPs are looking for exits and refinancing options. But interest rates are no longer at ultra-low levels, and geopolitical tensions and the rise of AI have introduced new uncertainty into many a portfolio company’s business model. This means higher discount rates, higher refinancing costs and a more challenging exit market than the dealmakers of 2021 may have envisaged.
So much for the theory, but what do the numbers say?
For Buyout investors, there is not much sugarcoating to be done.
Looking at the current performance of Buyout funds, vintage year 2021 does seem to have low returns (see table 1). But for a fair comparison, we should look at how the vintage compares to other funds when they were at the same age.
Measured in Net IRR or net multiple, 2021 looks like a poor year (see table 2). 2020 looks pretty weak too, which marries well with the narrative we described above. Yet while these are below average, they are not unprecedentedly so. In fact, 2015 looks slightly worse.
The real story here is in the distributions. Median DPI (“distributed to paid in”), a measure of how much capital funds have returned to their investors, for 2021 stands at only 14.8% (or c. 0.15x), less than half the average at this stage of maturity (for the 2014 to 2021 reference vintages). The Net IRR and Net Multiple figures quoted therefore rely more heavily on valuations than those of the earlier vintages shown. Although it is true that there is little real evidence of systematic overreporting of NAVs in private equity portfolios, the combination of low realizations and more challenging market conditions does make relying on current PE valuations a little uncomfortable.
For Direct Lending funds, the situations is more nuanced. As most readers will be aware, Direct Lending loans are typically floating rate. In simple terms then, higher interest rates mean higher financing costs for the equity owner (i.e. the Buyout fund) and higher returns for the lender (i.e. the Direct Lending fund).
It is, of course, not all positive for lenders. These same higher financing costs may push some borrowers into financial distress or mean that loans will not be refinanced as early as expected, leading to lower all-in returns. While a lender may be able to manage the former to their advantage, the latter is solely negative. “Equity kickers”, small equity participations that some lenders negotiate, will likely have performed worse, on average, in line with the fate of the Buyout funds.
The other factor, which has been the focal point of media coverage, is that the alleged sloppy underwriting during the “heydays” of 2021 will also take its toll on performance.
Again we can look to the vintage year comparison for some evidence.
Per the most recent performance figures (table 3, above), the 2021 Direct Lending peer group does not stand out negatively. Even when measured against where previous vintages stood at the same point in their fund life (table 4, below), 2021 looks average rather than bad.
And DPI? That looks pretty average too…
Perhaps this is not too surprising. Direct Lending benefits directly from the higher rates but suffers from delayed exits and refinancings, and from the broader strain in the market. In nominal terms at least, these factors seem to offset each other pretty well.
The final observation I would like to make: vintage year diversification is important in private equity and is a natural part of investing in private market funds. There will always be good and bad vintage years, but investors deploying (and redeploying) capital across vintages needn’t lose any sleep.
TL/DR summary:
Yes, the vintage year 2021 is looking like a poor one for Buyout funds
The floating rate nature of Direct Lending appears to counteract the negative consequences of higher interest rates for borrowers
Vintage year diversification matters! This is just another sign not to put all of your eggs in one basket.
Note: Not investment advice, all errors are my own.