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Private Equity Bracing for Higher Rates

Investors big and small are steeling themselves for the day the Federal Reserve ends its easy money policy, known as QE3. How they and the markets will react to a new environment was a big topic at the Deutsche Bank Global Financial Services Conference in New York this week.

Deutsche Bank Co-Chairman Anshu Jain called the prospect of the withdrawal of liquidity "concerning," but BlackRock CEO Larry Fink was far more sanguine.

There is too much discussion of "when, and if, and how the Federal Reserve will change its policy," Fink said. He does not think it will matter, because the central bank will be measured in tapering its bond-buying, as it has been in selling other assets it accumulated during the financial crisis.

Fink's sentiment was echoed by John Eydenberg, Deutche Bank's global head of financial sponsors. He told CNBC that higher rates should not have a big impact on the private equity market for a number of reasons.

First, Eydenberg expects the surge in initial public offerings to continue through the year. That should allow PE firms to cash in on investments they have made over the past few years. If rates tick higher, he said, the appetite for new offerings should remain robust.

Second, even if rates rise a few percentage points, they will still be below average on a historical basis, Eydenberg said. So leveraged buyouts, or takeovers funded by high-yield debt, should make sense for a number of companies even if investors hit the pause button to assess rates' impact on the markets.

Real estate is an interest-rate sensitive area in which private equity has been especially active this year. Blackstone's Invitation Homes spent $4.5 billion buying 26,000 homes through April. Like other firms, it is purchasing distressed properties and renting them out.

The interest from big investors is helping to drive up home prices, but the concern is that they are squeezing out retail homebuyers and re-inflating a bubble in housing and rental prices.

Eydenberg believes that private equity's bet on real estate remains a smart one, even if higher rates threaten to boosting the costs of owning a home.

Tested by the financial crisis, PE firms have become more patient with their investments, he said. They have become so partly out of necessity, as a recovering stock market could not generate the appetite for IPOs of companies that firms bought and restructured with the intent of taking them public again.

At the same time, PE firms' investments in fledgling companies have not paid off as quickly as in prior periods—again because of start-ups' reluctance or inability to go public. Private equity's newfound patience reflects a change that Eydenberg said he sees as permanent.

—By CNBC's Mary Thompson. Follow her on Twitter @MThompsonCNBC

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