The tariffs challenge for private markets

It takes two to tango. But how to dance when the lead changes direction with every beat of the music? This is the challenge faced by the US’s economic partners since 2 April: significant increases in trade tariffs were announced, then some of them were rolled back, others significantly increased, and a large number postponed until 9 July and then further to 1 August. Uncertainty increased on 28 May, when the US Court of International Trade ruled that the executive branch had exceeded its authority by imposing these tariffs. However, the next day, the Court of Appeals for the Federal Circuit allowed them to remain in place pending a full examination on 31 July.

This uncertainty affects private markets: it is difficult to invest for a four-to-seven-year time horizon when rules and regulations are so difficult to predict. Still, a few constants and guiding principles for investors can be outlined.

1. Diversify: Invest broadly instead of trying to pick winners 

The first principle is to diversify. At first glance, this could seem like a tall order, given that the US alone represents 50% to 60% of the PE market. Investors vote with their wallet, and in challenging times there is a clear preference for Western markets and their perceived safety. Shifting the focus to Europe could look appealing, but if all investors do the same (‘herding effect’), excessive capital inflows will push valuations up and depress future returns. Said differently, it is challenging to diversify away from the US as it provides an attractive and dynamic environment to build businesses. It is unlikely that the shareholder value provided by top US companies can be replicated abroad. It is prudent to continue deploying capital broadly across Western markets rather than trying to pick a geographical winner.

2. Invest in a consistent, disciplined manner over time 

Beyond geography, time is a crucial factor in diversifying private market investments. More than ever, the core guiding principle of investing remains ‘do not try to time the market’. A sound investment programme should deploy capital like a metronome, in a consistent and disciplined manner over multiple years to reduce the risk of being wrong-footed by a market shift. Investing in a long sequence of private market funds, with an initial ramp-up phase ideally spanning five to seven years, effectively reduces the impact of mediocre vintage years on a portfolio, while increasing the chances of including good ones.

This is visible, for example, in the case of LBO investing, which consists of acquiring mature and profitable companies with some borrowed money, transforming them and eventually selling (or listing) them at a profit. Investing in LBOs is equivalent to an ‘all-weather’ strategy, meaning that it usually generates variable but positive net performances. However, as illustrated by historical patterns, LBOs tend to perform less well during economic and market peaks, and better during troughs and recoveries. Indeed, the net median multiples of the capital paid into PE funds ranges from 1.47 times (x) in 2006 (an economic and market peak) to 1.93x in 2001 (a recession year).

3. Choose your managers wisely

Beyond consistency and discipline, the selection of private market fund managers matters more than ever: they have significant agency, given their broad mandate, and they are the closest to the ground. The best ones are effectively experts at avoiding or handling obstacles. Indeed, top quartile LBO fund managers outperform the median the most during and after recessions. The highest levels were in 2000 to 2002 with a 30% to 35% outperformance, and 2009 to 2012 with a 32% to 38% outperformance.

When it comes to new investments in a private company or asset, the potential impact of tariffs is mixed. Since new private market funds usually have a five-year investment period, managers have time to conduct thorough due diligence until they have the necessary level of comfort to proceed with investments. However, the unpredictability of these tariffs could limit these assessments and the use of precautionary measures.

As for existing investments, tariff damage largely depends on the industrial exposure of companies in the portfolio. Looking at LBO investments between 2020 and 2024, exposure to the industrials and raw materials & natural resources sectors, which are primary tariff targets, represents 22% of the number of investments, and 17% of the capital invested. Semiconductors, another prime target of tariffs, represent a small fraction of the information technology sector, which could be an indirect victim, along with consumer cyclicals. These two sectors were recently the top categories for LBO investments. 

Where do we go from here?

The private market sector’s activity is an immediate victim of uncertainties. Exits via trade sales or initial public offerings were already slow, due to the challenges of valuing companies in the tumultuous environment sparked by the abrupt and significant rise in Western-market interest rates. As a result, fund managers held onto assets, and distributions to investors were reduced. As a ripple effect, investors committed less capital less frequently to new private market funds. This might ultimately constrain the ability of fund managers to deploy capital. The general ‘wait and see’ attitude is also detrimental to the performance measured through the time-sensitive internal rate of return.

To address these challenges:

1. Fund investors are rearranging their investments: They're selling stakes in private market funds they own to other buyers on what's called the "secondary market". This market has seen a record high of $162 billion in transactions in 2024, which is 45% more than in 2023.
2. Fund managers are offering liquidity windows: They are creating new funds, called "continuation funds", to take over some of the private companies they already own. This helps them free up some cash. Others are borrowing money against their existing investments to get some cash out early.

However, these solutions are only temporary fixes. The real issue is that there are still many unsold assets in LBO funds, worth around $3.1 trillion. For private markets to really recover, the usual ways of selling these assets need to become available again. But, there's a risk that trade tensions and tariffs could disrupt this process and prevent private markets from getting back on track.