Written by Marc Syz, managing director and CEO of Syz Capital
It has been said that if cash is king for businesses, then DPI (distributions paid-in) is king for limited partners in the private equity world. Indeed, the metric’s growing influence was amusingly highlighted by a recent report that described how an investor arrived at a private equity conference bedecked in a T-shirt that carried the slogan: “DPI is the new IRR.”
DPI importance was also underscored by a 2023 Capstone survey which showed that the impact of lower distributions caused greater concern among investors than macro-economic conditions.
Is DPI the new IRR?
We believe that to accurately forecast the performance of the present fund generations, it is crucial to scrutinise their existing DPI. DPI’s focus on the payback period in present value terms can offer a more tangible sense of investment risk, especially for projects where recouping the initial outlay quickly is critical.
So, if DPI is the new IRR – how is the metric faring and what does it tell us about the current state of play in private equity?
Anatomy of the DPI slowdown
European private equity is currently experiencing a modest slowdown in exit activity which results in lower-than-expected distributions. The value of exits in 2022 dropped by 32% compared to 2021 and did not recover in 2023. On the contrary, the number of exits has not materially decreased since 2021 levels.
The big drop in exit value, coupled with an almost stable number of exits, suggests the slowdown in exit activity is mostly attributable to a low number of large-cap deals. And this is supported by the data: in 2022, the value of large-cap exits almost halved compared to 2021 and has yet to bounce back.
In contrast, the value of exits for European lower mid-market funds has been stable across 2021-2023. Therefore, the current decline in EU private equity distributions is mostly attributable to subdued exit activity in the large-cap segment. This is testament to the resilience of the European lower mid-market versus the large-cap segment.
Mid-market resilience
When comparing Europe with the US, the lack of distributions in private equity is mostly attributable to US funds, which have experienced deeper drops in exit activity.
US exit value in 2022 dropped by 63% vs 2021 and further decreased by 8% in 2023. The number of exits also decreased, with 26% less exits in 2022 compared to 2021, and 17% less exits in 2023 compared to 2022.
Again, the percentage decrease in the number of exits does not follow the percentage drop in exit value, meaning that the lack of distributions is mainly triggered by a lower number of large-cap exits.
And even though the US lower mid-market is suffering moderately due to the subdued exit activity, it is way more resilient than the large-cap segment.
We have always been mindful about returning capital to our investors. This is a common denominator of any of our strategies,across our illiquid funds.
Secondaries heat-up
Due to the lack of distributions, the secondary market is also hot at the moment. This is true especially in the lower end of the market as most of the secondary players are too big to execute small secondary transactions.
Good investing is not just about returns but selecting investments that also allow you to sleep at night. The current environment stresses once again the benefit of allocating to uncorrelated strategies, such as legal assets, that do not rely too much on market beta and are not prone to acute volatility. For true portfolio diversification, it is not just about alternatives but finding alternatives within alternatives to actually fulfil this prerogative.
