Why it might be a new day for growth equity

We have long believed that growth equity offers exposure to some of the largest, fastest, growing private companies in the world, particularly in sectors such as Artificial Intelligence (AI), social media, financial services and data intelligence. We see this as an important role to play in our client’s portfolios. And experience suggests that investing in highly-innovative companies via private markets can offer the potential for long-term above-trend returns while providing exposure not accessible in public markets.

We define “growth equity” as investments in newly founded private companies, generally less than 10 years old, that are leaders in highly innovative sectors like technology, healthcare and climate. Many are based in the U.S. or high-growth regions such as India, Southeast Asia and Latin America. They typically are experiencing revenue growth rates that may exceed their public market counterparts¹.

We help our clients access these opportunities by partnering with experienced growth equity managers who take an approach that is diversified across sectors and geography to help in seeking to mitigate the risks associated with investing in growth equity. When possible, we favor managers who can provide value-add operating guidance and resources to entrepreneurs.

In this article, we’ll review the reasons we believe that investing in this space can be beneficial, and our approach to getting it right. We’ll also explain why we think the space offers some potentially intriguing opportunities today.

The why of growth equity

In keeping with our view that private-market assets have the potential to outperform public equities and bonds over the long term, clients may consider allocating a portion of their portfolios to these assets to potentially strengthen their return profiles.

Alongside other classes like core private equity and real assets, we see growth equity as an important element of this approach. Typically, we suggest that clients consider allocating between 10% and 30% of their private investment funds specifically to growth equity—although clients with longer time horizons sometimes opt for larger allocations. 

The reason for this is simple: Growth equity companies tend to be earlier in their life cycles than publicly-traded companies, and they may have greater growth potential—but come with correspondingly greater risk.

It’s important in this context to distinguish between growth equity and other types of investments. Compared to venture capital, growth equity investments are typically made in more mature businesses. These companies already have proven business models and some recurring revenues. In many cases, they are profitable. That has been an increasing focus over the past three years: Our data shows that profitable companies are commanding greater multiples from investors.

However, growth equity strategies generally focus on younger and less mature companies than do private equity strategies. This allows growth equity investors to access companies that can achieve greater growth and generate greater alpha, again with correspondingly greater risk.

Today, we see outstanding levels of innovation in artificial intelligence (AI), life sciences, hardware and energy transition-related technologies. We are bullish on areas including:

• The digital transition in areas like AI and machine learning, digital payments, and cybersecurity
• Healthcare Innovation in areas like life sciences therapeutics, tools & services and value-based case
• Energy transition including next-gen renewables, sustainable materials & products, and decarbonization
• Evolving consumer preferences in e-commerce and marketplaces and direct-to-consumer brands

And the why now

Today, investors who are willing to add exposure may be able to invest in growth-stage companies at far lower valuations than those that were available a few years ago—even though many of those companies have continued to build their customer bases, grow revenues and prove the strength of their businesses in the interim.

Growth equity companies have endured substantial declines in market value since their valuations peaked in 2021-22. While high-growth public equities began a similar downturn at around the same time, their valuations have generally recovered – especially if they are profitable. That hasn’t been the case for private companies.

Valuations for growth-stage investments have fallen by more than half from their peak, as this chart shows: