For years, private equity managers have benefited from multiple expansion, enabled by an era of near-zero interest rates. In essence, multiple expansion occurs when investors are willing to pay more for each dollar of a company’s earnings—akin to rising P/E ratios seen in public companies over recent years.

Today, however, higher interest rates are putting downward pressure on valuation multiples, thus private equity value creation will increasingly depend on margin expansion, in other words, improving a company’s profitability by increasing earnings relative to revenue—i.e., generating more profit per dollar of sales.

Historically underemphasized, this factor contributed just 10 basis points to median value creation over the past decade, signaling meaningful room for improvement in a higher interest rate environment.

For years, private equity managers have benefited from multiple expansion, enabled by an era of near-zero interest rates. In essence, multiple expansion occurs when investors are willing to pay more for each dollar of a company’s earnings—akin to rising P/E ratios seen in public companies over recent years.

Today, however, higher interest rates are putting downward pressure on valuation multiples, thus private equity value creation will increasingly depend on margin expansion, in other words, improving a company’s profitability by increasing earnings relative to revenue—i.e., generating more profit per dollar of sales.

Historically underemphasized, this factor contributed just 10 basis points to median value creation over the past decade, signaling meaningful room for improvement in a higher interest rate environment.

Despite this, margin expansion is still important for top-quartile private equity deals. As shown below, margin expansion accounted for 15% of the value creation drivers for the top private equity global buyout deals.

These outperforming investments have generated a significant share of their value creation through operational improvements and enhanced profitability. It also is important to note that top-quartile deals also commanded higher exit multiples—highlighting that investors are willing to pay a premium for businesses that demonstrate operational margin expansion.

The Art of Expanding Margins

Unlike multiple expansion, which is highly sensitive to market cycles and macroeconomic uncertainty, profit margins are more controllable. Private equity managers can create value—and build resilience—by expanding margins through operational expertise. This approach positions portfolio companies to perform more consistently, regardless of the prevailing interest rate environment or trade policy shifts (See the chart below).

Summing Up

With valuation multiples under pressure and elevated interest rates likely to remain a structural feature, private equity managers must rely less on market-driven tailwinds and more on what they can directly control: operations. The ability to drive returns through margin expansion—improving efficiency, optimizing cost structures, and unlocking value at the portfolio company level—has become a critical differentiator.

This operational approach not only drives performance but also builds resilience amid uncertainty, enabling managers to create value independent of market cycles or macro conditions. In the new era of structurally higher rates, the capacity to generate returns through margin expansion may well define the next generation of top-performing managers.

Read more in our Alts Quarterly Q3 2025.

A WORD ABOUT RISK

As an asset class, private credit comprises a large variety of different debt instruments. While each has its own risk and return profile, private credit assets generally have increased risk of default, due to their typical opportunistic focus on companies with limited funding options, in comparison with their public equivalents.

Because private credit usually involves lending to below-investment-grade or non-rated issuers, yield on private credit assets is increased in return for taking on increased risk.

Investments in real estate-related instruments may be affected by economic, legal or environmental factors that affect property values, rents or occupancies of real estate. Infrastructure companies may be subject to a variety of factors that may adversely affect their business, including high interest costs, high leverage, regulation costs, economic slowdown, surplus capacity, increased competition, lack of fuel availability and energy conservation policies.

Alternative investments often are speculative and include a high degree of risk. Investors could lose all or a substantial amount of their investment. High-yield bonds are subject to interest rate risk. When interest rates rise, bond prices fall; generally, the longer a bond’s maturity, the more sensitive it is to this risk. Yields are subject to change with economic conditions. Yield is only one factor that should be considered when making an investment decision.

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INDEX DEFINITIONS

Bloomberg Global Aggregate Index is a market capitalization-weighted index, comprising globally traded investment grade bonds. The index includes government securities, mortgage backed securities, asset-backed securities and corporate securities to simulate the universe of bonds in the market. The maturities of the bonds in the index are more than one year.

Bloomberg U.S. Corporate High Yield Bond Index measures the USD-denominated, high yield, fixed-rate corporate bond market. Securities are classified as high yield if the middle rating of Moody’s, Fitch and S&P is Ba1/BB+/BB+ or below.

Cliffwater Direct Lending Index (CDLI) seeks to measure the unlevered, gross- of-fee performance of U.S. middle-market corporate loans, as represented by the asset-weighted performance of the underlying assets of business development companies (BDCs), including both exchange-traded and unlisted BDCs, subject to certain eligibility requirements.

FTSE EPRA Nareit Developed Real Estate Index is an unmanaged market- capitalization-weighted total-return index that consists of publicly traded equity REITs and listed property companies from developed markets.

FTSE Global Core Infrastructure 50/50 Index gives participants an industry-defined interpretation of infrastructure and adjusts the exposure to certain infrastructure subsectors. The constituent weights are adjusted as part of the semi-annual review according to three broad industry sectors: 50 Utilities; 30 Transportation, including capping of 7.5 for railroads/ railways; and a 20 mix of other sectors including pipelines, satellites and telecommunication towers. Company weights within each group are adjusted in proportion to their investable market capitalization.

MSCI World Index is a free-float-adjusted market-capitalization-weighted index that is designed to measure the equity market performance of developed markets.

Nasdaq Index is a market-cap-weighted index tracking companies traded on the Nasdaq stock market.

Preqin Infrastructure Index captures in an index the return earned by investors on average in their private infrastructure portfolios, based on the actual amount of money invested in private capital partnerships. Each data point is individually calculated from the pool of closed-end funds for which comprehensive performance data is held, as of both the start and end of the quarter.

Preqin Private Equity Index captures in an index the return earned by investors on average in their private equity portfolios, based on the actual amount of money invested in private capital partnerships. Each data point is individually calculated from the pool of closed-end funds for which comprehensive performance data is held, as of both the start and end of the quarter.

Preqin Real Estate Index captures in an index the return earned by investors on average in their private real estate portfolios, based on the actual amount of money invested in private capital partnerships. Each data point is individually calculated from the pool of closed-end funds for which comprehensive performance data is held, as of both the start and end of the quarter.

S&P 500 Index is a market-cap-weighted equity index of 500 widely held, large-capitalization U.S. companies.