PE valuations and dry powder levels are the two most discussed aspects of the industry today, and they are not unrelated. They symbiotically feed off each other, driving investors to pay higher markups for deals and raise more capital to prepare themselves for more of the same going forward.
But PE valuations don't operate in a vacuum, and the LPs who ultimately finance them are free to look elsewhere to park their money. They don't particularly want to—alternatives are a staple in most portfolios and provide much-needed, uncorrelated returns to equities. But in exchange for the liquidity tie-up, PE's selling point is higher returns.
That becomes significant and much harder to achieve when entry prices are higher. If LPs are paying comparable prices for their private and public holdings, PE's lack of liquidity comes more clearly into focus.
An article from The Financial Times pointed out the problem last year: "Industry observers also said that a narrowing of the gap would lead some to reassess their exposure to private equity."
That's true, though it would be an overstatement to etch it into stone ahead of time.
This column originally appeared in The Lead Left.
Read more about PE valuations in our 2018 Annual US PE Middle Market Report.