Advisors weigh PE allocations in face of rising rates

investmentnews.com:

If rates remain high, or climb even higher, should advisors pull the plug on PE? When both legs of the 60/40 portfolio – stocks and bonds, that is – wobbled back in 2022, advisors found refuge in private equity products, whose liquidity is typically more like syrup dripping from a jar than water cascading off a cliff.

A more viscous, stickier investment if you will. Perfect for stemming the flow of fast money moving in or out.

Two years ago this week, when all that craziness was going on, the yield on the 10-year Treasury note was 2.83 percent. It finished the year at 3.75 percent.

Fast forward to today, and after a hotter-than-expected March CPI report and a disappointing Treasury auction this week, the 10-year Treasury is now loitering near the 4.5 percent mark. Moreover, Wall Street’s forecast for six Federal Reserve rate cuts last year has plummeted to 2 or less, so the outlook for lower rates ahead has grown even dimmer.

That’s generally a bad thing for PE investors – at least according to conventional wisdom.

If the typical PE firm employs leverage and the cost of borrowing rises, it would make sense that the higher interest rates would cut into its returns. Furthermore, the debt on the balance sheets of the PE company’s portfolio companies would be hit, and the earnings of those companies could be negatively impacted by higher interest costs as well.

Longer term, a growing economy allows for innovative companies to increase their sales and earnings at a rate high enough to offset the incremental interest cost, says Craig Warnimont, chief investment officer at Venture Visionary Partners, who typically does not add private equity to client portfolios.

“The decision to add or subtract from your allocation comes down