Today’s investing environment is truly a new macroeconomic regime. Globally, we are facing labour shortages and dramatic shifts to the world’s demographics. We are witnessing record fiscal impulse across most of the globe, and an inflationary energy transition that is not as disinflationary as digital capex. And this occurs as rising geopolitical tensions and realignments create new dynamics for investors to navigate. It’s fair to say that the challenges investors face today are unlike the challenges we’ve seen in the past.

Yet against this more challenging backdrop, we think there is a case for private equity to play a meaningful role in optimising returns across a variety of economic environments.

Similar to private credit, private real estate and private infrastructure, our view is that private equity can be additive to traditional investment portfolios, especially for investors who are concerned about inflation or do not face meaningful near-term liquidity constraints. In fact, there’s an argument to make that investors are better served today by more diversified portfolios that are enhanced from the traditional ‘60/40’ portfolio mix of equities and fixed income.

To drill down further, according to historical data, private equity investments generally outperform public stocks in most economic environments (except during times of rapid valuation re-rating). During periods of high inflation, like the one we are currently living through, data shows that private equity has generated returns that are 6% higher than those achieved through similar sized investments in public market equities.

How is this persistent performance achieved? The answer lies in private equity’s active capital model: investments in the private market are not passive investments. Returns are created through the active management and operational improvements in the companies in which private equity managers invest. This may include revenue and cost optimisation to protect and grow margins, through expansion into new markets, corporate carve-out strategies, by improving working capital, and by fostering employee engagement and aligning incentives. These are just a few ways in which private equity investors seek to unlock value in their portfolio of companies – and in doing so, can create shared benefits for investors, portfolio company employees, and communities at large.

These strategies take time to bear fruit, yet private equity classifies itself as ‘patient capital,’ which entails taking a long-term view of a company’s operations regardless of the short-term fluctuations in the markets. This approach enables a private equity manager to effect real changes to a company to generate higher growth and command higher multiples than would a set of equivalent public stocks.

However, in this complex environment, it’s important to get the balance right: a broader, more integrated toolkit, including macro analysis, liability management, downside protection, hedging, and portfolio construction are required. And while there are benefits of investing in private equity, it’s also worth highlighting that studies that show the dispersion of returns across private market funds is higher than the dispersion of returns across listed market funds. In this regard, one of the most important considerations for any investor would be manager selection.

As we look forward, we think there is a compelling case for private equity investment amidst this evolving macro regime, and are optimistic about what this sector can achieve.

Authors: Frances Lim, Managing Director, Head of Asia Pacific Macro, KKR and Anna Kilmartin, Principal, Private Equity – Australia, KKR.