Fed Rate Cut—Sharpened Landscape for Private Equity or Another Foil?

At what is almost the last quarter of 2024, the US Federal Open Market Committee (FOMC) has seemingly decided to approach the end of the year in a different note by slashing the Federal Reserve funds target by 50 basis points (bps) to 4.75%–5.00% in what appears to be the beginning of a new monetary easing cycle.

Aswath Damodaran probably put it most interestingly (and somewhat accurately) when he said that the rate cut was anti-climatic and similar to “watching an elephant in labour deliver a mouse”. To be fair, markets seemed to have already anticipated at least a 25bps clip in the overnight borrowing rate but were just divided on timing.

But a rate cut is still a rate cut, and this potentially points towards the culmination of a “higher-for-longer” era of interest rates. J.P. Morgan has gone as far as to expect the Fed to further drop rates by another 50 bps at the next FOMC meeting in November 2024, with interest rate futures contracts now reflecting a 54% chance of a half-point cut. Even more interestingly, the Federal Reserve’s own forecast expects four more 25 bps cuts—or a total of 100 bps—in 2025.

^{Median Values, end-of-year, J.P. Morgan}

So what does this all mean for investors in Southeast Asia? More specifically for investors who are looking into the private equity (PE) landscape?

Regional PE activity has noticeably weakened over recent years owing to pandemic-led impacts on economic activity and then further strained by other knock-on effects on exit ability and sponsors’ ability to return capital. We are supposing three main themes will play out in a lower rate environment:

1. Stronger entry and exit support through debt financing

Following the FOMC announcement, several Southeast Asian markets saw corresponding pullbacks in mid-term treasury rates, with Philippines already eased in August and Indonesia targeted by economists to follow shortly.

^{Federal Funds Rate (Actual vs. Expected) and 5-Year Government Bond Yields in Major SEA Countries
Source: Bloomberg, as of 27/9/2024.}

Falling rates typically mean lower costs of borrowing for stakeholders in the financial markets, including private equity sponsors, which opens up a plethora of options previously considered economically unfeasible.

For instance, in the previously high-rate environment, using debt to enhance equity returns (e.g., acquisition financing in leveraged buyouts) was considered challenging since lenders were charging Southeast Asian PE sponsors 5%–7% above benchmark rates, which meant debt servicing became tougher affecting ability to pay. As debt costs become more reasonable, these thresholds may come down and PE investors may find more addressable targets to acquire or invest in.

Cheaper debt also makes distributing capital through dividend recapitalisations much more achievable, which is one avenue for alleviating the problem of starved distributed to paid-in capital ratio (DPIs) for Southeast Asian general partners (GPs).

2. Growing base of companies becoming increasingly PE-ready

Lower debt financing rates do not just empower PE investors, they also support corporate growth by making it cheaper to fund organic and inorganic expansion which may bring them to a size that is ready for private equity investment (and divestment).

Companies may also look towards acquiring vertically and horizontally across the value chain in a bid to grow in scale and/or scope. Cheaper debt would mean stronger buying power and potentially a healthier financial return on investment. PE-backed companies seeking to perform roll-ups may also be able to achieve the same goals of getting towards a more exit-friendly scale.

Based on transaction data from Capital IQ, Southeast Asian multiples are already trending upwards, with regional transactions underwritten in August 2024 and September 2024 at median EBITDA multiples of 14.1x and 17.9x, respectively, compared to the 2023 median of 12.6x—potentially pointing towards investors pricing in the aforementioned growth potential in the lower rate environment ahead.

3. Increased attention towards private equity as an asset class

Southeast Asia-focused GPs have found it challenging to raise capital over the last few years, in particular for private equity. With base rates at the levels they were in 2021-2023, private credit managers have been able to deliver double digit returns stealing attention and allocation from other asset classes.

That may now have changed with fund managers looking to lock in LP commitments that will enable them to stay ahead of the market not if but when it turns. DealstreetAsia has reported that there are over 65 funds with Southeast Asia allocations raising capital (28 of which are fully focused on Southeast Asia) and over a third of targets already raised for the Southeast Asia-focused funds.

While most of the funds raised (by value) are more pan-Asian focused, Southeast Asian names, such as Creador and Growtheum, have also raised significant amounts to deploy into key ASEAN markets, indicating the intent to attract what could possibly be renewed intention to look into private equity interest from LPs in anticipation of a lower-rate environment.

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There’s much to anticipate in Southeast Asia private equity in the month ahead following the announced (and anticipated) rate cuts. Additionally the China economic stimulus package announced at end-September should provide a boost to market sentiment towards economic growth in the region with ASEAN and China being each other’s largest trading partners.

Nonetheless, other intrinsic challenges remain, including identifying the key sectors that are poised for growth and the right players to back in each. Aura Private Equity’s Back to the Future strategy incorporates a data-driven approach to guide our focus on the most relevant industries and sectors to deep dive into, by triangulating indicators of liquidity (transaction activity, valuations, and sponsor activity) with market size and quality of business across ASEAN economies and its more advanced PE market counterparts such as China, India and South Korea.

The U.S. rate cuts create a unique environment for Southeast Asia’s private equity landscape, opening up avenues for growth, capital inflow, and investment diversification. With abundant opportunities in sectors like technology, infrastructure, and consumer goods, the region is positioned to attract more attention from global investors seeking higher returns and new markets.

Find out more about Aura Private Equity and discover hidden gems in the region by utilising our in-depth reports.