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Case Study: High Inflation and PE Deal Performance

Part 1: US deal returns during rising and high inflation (1986-1991)

maja 26, 2022
min read

How high inflation affects private equity investment is a complicated question. But the industry has undergone previous periods in similar environments. To offer a case study into how historic deals have performed in these circumstances, we look at private equity deal returns during the previous historic period of high inflation: 1989-91.

Methodology
- In order to explore how private equity deals had performed in previous periods of high inflation, we looked for a previous period of similarly high inflation.
- Given the sharp inflation peak and deflation trough seen in 2008, it does not make for a like-for-like comparison. 1988-91, however, saw a sustained period of high inflation in the 4-6% bracket, surpassing 6% in September-December 1990.
- The 1989-91 period was chosen on the basis that inflation remained consistently above 4% from January 1988, before falling back toward 3% by the end of 1991.
- The pre-inflation period of 1986-88 was chosen as a comparable period marked by a fall in inflation in February 1986, rising to around the 4% threshold by late 1988.
- We compiled DealEdge deal-level performance data covering these two periods in order to examine how returns were affected by these circumstances.
- We focused on buyout and growth deals in the US in order to eliminate complications arising from relative currency valuations and uneven global inflation levels.

US Federal Reserve CPI Index and Year on Year Inflation chart — The last time US inflation passed 6% was in September-December 1990

Using US Federal Reserve data, we identified the last time inflation reached 6%, in late 1990. We further identified two phases: a pre-inflation period in 1986-88, and a high-inflation period in 1989-91.
We then examined the returns of US private equity deals entered during these two phases, to see how high inflation affected performance in the industry.

Median US Deal IRRs by Year of Entry chart — Deals in the pre-inflation period have markedly lower returns than those entered in the high inflation period

Deals entered in 1986-88 had generally lower median IRRs than their counterparts entered in 1989-91. In fact, median returns in 1991 were more than twice as high as in 1986.
Returns fell across most quartiles from 1986-88, before climbing successively to 1991. Bottom quartile returns did not exceed negative 15% at all in the pre-inflation period.
The difference between the top and bottom quartiles was mostly consistent throughout, ranging from 50 to 62 percentage points across 1987-1991. Deals made in 1986 saw a much wider spread of 87pp.

Read the second part of our case study where we continue to look at the previous high inflation period of 1989-91 to examine the drivers behind the overall performance picture.

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