After more than a decade of historically low interest rates, the monetary cycle shifted abruptly starting in 2022. In response to persistent inflation, the European Central Bank raised its benchmark rate from 0% to 4% in just 18 months. This pivot tightened financial conditions across Europe and dramatically increased the cost of capital, transforming the playing field for investors and managers. Although 2025 has ushered in a moderate phase of cuts, real interest rates remain positive, and the environment continues to be characterized by greater credit prudence and less financial exuberance.
This new regime has had a profound and quantifiable impact on alternative investment strategies, from private equity to special situations, including listed equity investments and the financial sector. Access to financing has been reshaped, valuations adjusted, risk premiums widened, and entry and exit dynamics altered. Far from being a transitory phenomenon, this is a structural reordering that demands a critical review of strategies, return metrics, and asset allocation criteria.
Understanding these effects is essential for any investor with exposure to illiquid or long-cycle assets. Likewise, this volatile environment has tested classic valuation methodologies, forcing funds to refine their estimation and sensitivity techniques. For a more detailed view on this aspect, we recommend our analysis on how to value assets in volatile environments: advanced techniques for private equity.
How rising interest rates affect private equity
Private equity, particularly in its buyout segment, has been directly affected by the increased cost of financing. The traditional leverage-based mechanism has lost effectiveness: with more expensive debt and reduced borrowing capacity, funds must contribute more equity or accept lower expected returns. In Spain, this translated into a 46% reduction in invested volume in the first half of 2023, while the number of deals barely fell, reflecting the relative resilience of the mid-market compared to large leveraged buyouts.
Regarding valuations, the increased cost of capital has led to a contraction in paid multiples (EV/EBITDA), with particular severity in large-scale transactions. A gap has emerged between seller expectations—anchored to pre-2022 levels—and what buyers can justify in their current financial models. This has slowed down transactions and forced a revaluation of assets more in line with the new financial context.
Furthermore, many portfolio companies acquired during the low-interest-rate era now present vulnerable capital structures: high leverage which, with rates at 4%, has increased their debt servicing costs and deteriorated their liquidity. The result has been an uptick in restructurings, private refinancings, and insolvency proceedings, requiring managers to refocus their efforts on portfolio stabilization. Paradoxically, funds that maintained a low-leverage policy have emerged stronger, with more sustainable returns and less financial pressure.
A practical analysis of the impact on key sectors
The effect of interest rates has been heterogeneous depending on the sector and asset profile:
- Technology and venture capital: these were the first to feel the adjustment. With valuations based on future cash flows and lacking operational profitability, many startups suffered sharp corrections. In Spain, funding fell by 32% in 2023, and lower-valuation rounds (“down rounds”) became widespread, forcing entrepreneurs and investors to refocus their strategies on profitability and efficiency.
- Banking and insurance: these sectors have been major beneficiaries of the rate hike cycle. The widening of interest margins has sent profits soaring. In 2024, Spain’s six largest banks achieved record profits of over €31.7 billion, driven by higher loan costs versus restrained deposit remuneration. Shareholder profitability has been notably strengthened, albeit with latent risks in case of deteriorating credit quality.
- Real estate and infrastructure: these have suffered due to rising cap rates and a loss of relative attractiveness. Projects heavily reliant on debt, especially in renewables, have seen investment slow, while prime assets with predictable cash flows have proven more resilient. Listed real estate companies experienced significant corrections.
- Special situations and distressed assets: the rate hikes acted as a catalyst for financial stress. In Spain, corporate insolvencies rose by 22% in 2024, exceeding 9,000 cases, generating a growing flow of distressed assets, problematic debt, and recapitalization opportunities. Funds specializing in special situations have reactivated their deployment, demanding double-digit returns.
How to protect your strategy against monetary policy changes
In this new environment, managing interest rate exposure should be approached from a structural, not tactical, perspective. Some relevant lines of action for private investors include:
- Reduce reliance on leverage: evaluate portfolio capital structures and limit the weight of LBO strategies with high debt.
- Prioritize stable cash flows and pricing power: sectors like healthcare, B2B technology, education, or stable energy offer resilience in high-interest-rate and inflationary environments.
- Explore hybrid instruments and structured debt: these allow for modulating financial risk and accessing attractive returns without direct equity exposure in volatile environments.
- Adopt an opportunistic and counter-cyclical approach: the secondary market and the distressed universe offer attractive entry prices with proper risk management.
- Maintain execution capacity: preserve tactical liquidity (dry powder) to respond agilely to recapitalizations, secondary market opportunities, or forced portfolio adjustments.
Concrete recommendations for adjusting your portfolio
- Update valuation models and discount rates: incorporate realistic scenarios with structurally higher rates and adjust entry multiples.
- Rebalance sectoral and geographical allocation: value sectors, regions less exposed to leverage, and credit strategies can provide greater robustness.
- Prioritize managers with a track record in adverse cycles: in demanding environments, the quality of the management team and their adaptability make a key difference.
- Leverage the secondary market: acquiring stakes in funds at discounts of 15–25% to NAV can be an efficient way to increase exposure with lower implementation risk.
- Strengthen portfolio governance: actively exercise rights as an LP or co-investor to demand prudent measures in financial stress scenarios.
Conclusion: adaptability and discipline in the face of a new financial paradigm
The 2022–2024 period has marked the end of an era in European financial markets. The rise in interest rates has not been a transitory adjustment but a profound change in the fundamentals of valuation, financing, and returns for alternative strategies. Henceforth, the environment will reward discipline in entry prices, real value creation in underlying assets, and the tactical adaptability to more volatile cycles.
For private investors, this implies an exercise in professionalization regarding the selection, supervision, and diversification of their alternative strategies. Understanding the new risks—but also the opportunities arising from financial dislocation—will be key to positioning oneself well in this new phase. Those who have prepared with rigor and flexibility will not only preserve their capital but will also be able to capture attractive returns in an environment where the scarcity of well-managed capital will be a competitive advantage.
