• Private equity could grow by five times over the next decade.
  • Big firms will get bigger and smaller firms will specialize.
  • Firms will need to align with environment, social and governance expectations.

The modern private equity (PE) industry has come a long way from the junk bond and leveraged buyout days that characterized its early formation. In 1980, only a handful of firms existed, none of them household names, and private placements were little understood. Since then, the industry has grown exponentially, becoming a $4 trillion sector globally in the space of four decades.

While impressive, this growth could pale in comparison to what the next 10 years might bring. Not only is there massive headroom – PE currently represents less than 5% of total global assets under management (AuM) and less than 2% of total investable capital – several factors could give the industry a sky-high bounce.

The first is the unprecedented rate at which the industry is accumulating capital. AuM is growing at two times the rate of the rest of the market. Second, as fund sizes swell, PE’s influence is stretching across nearly every major sector of the economy. “Mega funds,” each with more than $10 billion in AuM, and some with twice that amount, are becoming a fixture of the PE environment.

Third, business and investor sentiment is shifting in favour of private placements as short-term earnings pressure, share price volatility and governance challenges sour some companies and backers on the public markets. Finally, the near-term economic outlook, though a bane for some, could be a boon for PE. With underperforming companies forced to devote attention and resources to shoring up balance sheets, well-positioned PE firms and portfolio companies can take advantage of the slack to advance their market position, embrace new investments, and fast-track business and operating model improvements.

But while the growth potential over the next ten years is significant, PE is going to have to work a lot harder than before to capture it.

If AuM swells by five times in the space of 10 years, as our analyses suggest it might, existing PE models will come under enormous pressure. Boosting returns amid ongoing economic, geopolitical and market uncertainty will require leaders to think, plan and invest in new ways – with a focus on value, an emphasis on digitization, and a commitment to evolving their internal and portfolio company organizational models.

The rising tide will not lift all boats. We’re likely to see greater bifurcation between huge funds and niche specialists. Big firms will get bigger and smaller firms will specialize. Organizational models will be pulled between the need to achieve scale on the one hand and diversification on the other. In the meantime, technology continues to advance. If time is money, earning it will require firms and portfolio companies to catch up with digital leaders and acquire advanced tools and capabilities.

Given the speed of change, it will no longer be enough to improve by increments. Firms must pull multiple transformation levers in parallel – within their own organizations and across their portfolio companies. They will need to think deeply and more creatively about how to attract and retain the skills needed – and more fundamentally about who they want to be. Are they content with becoming “boring asset managers” or can they capture and scale the smart, competitive energy that defined their early success and in ways that align with rising environment, social and governance (ESG) expectations?

We believe the answer is yes for those willing to embrace the following imperatives.

1. Create a differentiated go-to-market strategy

With mega funds, large sovereign wealth and pension funds, and select PE funds allocating landscape-shifting sums of capital, the gap between large players and the rest of the field will widen. The same strategies that worked over the past decade will not work going forward. Large funds will need deeper diversification, not just across industries, but also across geographies and asset classes. Smaller firms will need to resist attempting to service the entire value chain and instead look to dominate high-growth niches.

2. Design the firm of the future

As funds get larger and investment more diverse, PE will require expertise from multiple domains. Cross-deal-team integration around assets that have complementary characteristics will be crucial. Organizations also need to manage the tension between longer holding periods and near-term value creation. That balancing act requires building out the processes and culture to enable fail fast and learn quickly environments, while continuing to back transformational capabilities within their firm and across their portfolio companies.

3. Achieve digital transformation at scale

To help targets incubate new products and services, achieve competitive cost performance, and fine-tune their commercial strategies, firms must aggressively implement digital capabilities. PE leaders are uniquely positioned to pinpoint high-value opportunities. What they must now do is scale these insights across their targets – tapping advances such as machine learning, natural language processing, and process automation – to gain needed reach and dexterity.

4. Embrace the business imperative of diversity

The next 10 years will see a war for talent as big firms scale and smaller ones diversify. The ambitious, can-do culture that attracted the sharpest minds over the last two decades will go stale unless firms find a way to rejuvenate and redefine it for a new generation. Leaders need to manage their growth carefully lest they lose the cultural “mojo” that attracted so many bright, young people to the industry. They must also think creatively and develop career paths to build the firm’s digital competencies and provide the innovation edge needed. Building teams that feature greater diversity in terms of background and expertise will be crucial.

5. Optimize for social and business value

As a direct and indirect employer of millions of workers globally, firms need to embrace their role as holistic value creators and as industry stalwarts. Good corporate stewardship will be essential. Greenwashing remains an ongoing investor concern. To demonstrate credibility, managers need to make a concerted push to incorporate ESG metrics into their investment methodologies and demonstrate the financial value that comes from this approach.

Leaders that embrace the imperatives outlined here can turn PE into a force for good, with virtually no limit to how much they can grow.