Private Equity: an attractive place through uncertainty
Citywealth collected thoughts and suggestions from private equity experts to understand what changes are required in order to let private equity thrive in the present climate, going through private debt, investment strategies and other trends popular among individuals and companies.
Private equity firms have counted on a scrupulous analysis of the industry paired with reliable experience to drive returns. The question is, is this still enough to succeed despite current challenges?
The ever-changing world of private equity is facing some of the same macroscopic changes that are affecting other industries, such as inflation and rising interest rates. Citywealth collected thoughts and suggestions from private equity experts to understand what changes are required in order to let private equity thrive in the present climate, focusing on the pivotal importance of data strategy, going through private debt, private equity investment strategies and other trends popular among individuals and companies.
How should PE adapt in order to thrive?
The consequences of the current climate will differ depending on the type of the chosen private equity strategy. “At Mirova we do not use leverage, so for us rising interest rates are not a big issue; – explains Marc Roman, Head of Mirova impact private equity funds – We have to mention also Venture Capital funds. With the end of free cash, the lower-quality companies will struggle to refund themselves, so you can expect to see different and increasing rates in VC. We have decided to invest in companies with high growth rates, so we can continue to generate value even if the economy is less attractive. That said, we still have to be extremely careful about the impact of inflation on the operations and expenses of the companies we invest in. We look at business plans to make sure that the firms we invest in are really deploying strategies which will generate profits and are properly managed.”
Hugh Lloyd-Ellis, PwC partner and TS and UK Leader of Industry for Private Equity, states: “I think we are going through a number of different phases of the private equity model and now we are facing significant issues, such as inflation and rising interest rates. I believe this could lead to assets being held for longer. By consequence, private equity needs to do more with the assets during their ownership period to drive returns.”
Sectors which are less impacted by the crisis and/or have benefited from the latter can be a valid option. Marc shares that “A good investment can target companies that deploy innovation, have a positive impact on the environment and constructively look at renewable energy The companies which count on innovation are benefiting from trends that supersede the economic trends, could those be continuative trends or regulatory trends, and manage to deliver a good product even if in difficult situations.”
The key is data (strategy)
Nowadays a correct and comprehensive data strategy is fundamental to address complex issues that may occur, accelerating the whole process in favour of a speedy resolution. Sometimes data strategy is given for granted, but too often it is not correctly addressed, resulting in the misuse of this essential tool.
But is data strategy really on top of the list as the only vital tool to navigate strategic shifts and stay competitive on the market? Hugh is firm in saying that: “Building a strong data strategy is absolutely vital. I believe data enables better decisions to be made and better value creation to be achieved. If you really get under the skin of what is driving a business, of what is driving its costumer base or cost base, data is going to be essential. You need data to understand the business better in as much detail as possible”.
Marc comments: “We take decisions based on the quality of the companies we want to invest in and to do that we take in consideration various parameters. For us the quality of the management in a firm is crucial. As we know, a company is a collective of individuals and the skills and talent of the individuals running a firm is a key driver in the success of the firm and this is not addressed by data. I think data is critical because you need data about the market, therefore it is a great tool in your investment process, but we have to stress that it is not the only one. It is not the only piece you need to build a successful private equity strategy.”
More about private equity investments
“In an environment where financing your CapEx and your OpEx is more challenging, you have to focus on companies where the growth is driven by innovation, talents and execution and not only by building imponent infrastructures. We need to choose investments in favour of companies where the need for CapEx is not too high and those firms are extremely careful in terms of operational expenses.
Buyouts have been a focus and continue to be a big portion of the allocation because it is a way to deploy big tickets, a dynamic comes into play so if you have a lot of money to use, you still have attractive returns. We have observed that there is an increase in demand for growth strategies. The VC part remains more niche since it is riskier, you need to be extremely specialised. For larger investors it is less easy to allocate money and this is why a growth strategy can be preferable”, shares Marc.
Hugh adds: “What have been the best private equity investments in the last few years might not be the best over the next few years. We have had businesses which have struggled more through the pandemic but are now ready to thrive in the next economic phase. Looking at private equity investment strategies, we can concentrate on a type of strategy which is not cyclical, on a business that has performed well through periods of volatility and therefore has visible growth opportunities.”
Private debt investing
By 2019, the assets invested into private debt reached a record high of $812 billion, with the pre-pandemic expectation that it would exceed $1 trillion by 2020. That same year, the number of asset managers reached a high of 1,764, more than double the number of five years previous.* Investors find private debt investing extremely attractive as it reduces credit risks and peripheral risks which come with rising interest rates and this is can be possible by reducing the number of fixed income portfolios.
Not only risk reduction, private debt has also become an accepted category to diversify assets and is now part of many asset allocation strategies and provides access to markets that would be otherwise completely inaccessible to investors. To this regard, Hugh confirms: “Every deal I have worked on in the last few years, or in the last twelve months especially has some kind of alternative lending, for instance, in the form of credit fund of a private equity fund. Especially with credit funds, private equity is using different leverage models on deals.”
Talking about private debt, Marc says: “Our clients invest in private equity, but they also look at private debt. We deal with institutional investors that need to allocate investments to match the requirements of variables like pensions and insurance where you need to have a long-term view or medium-term view. Private assets are of growing importance for those clients. By consequence, if you are the CEO of one of those clients, even if you have a long-term view, you are dominated by short-term volatility and it is not always easy to keep your position. One of the reasons why we see an increase in the market for private assets is because it is a way for clients to deploy money in the long-term with lower pressure from the short-term volatility of the financial market.”
Trends and predictions
“To adapt, you have to be more careful about the companies you invest in, you have to challenge the business plan of the company more and focus on companies that have very attractive growth rates and also on companies which are in sectors where the growth is driven by factors that are not only economic parameters. I am a strong believer that increasing allocations to private assets is needed to allow investors to have a long-term view and to address the economy, especially in continents like Europe; – stresses Marc, who adds that – Economic growth is coming and we will continue to focus on medium-size companies that innovate and bring value not only to big firms. I think these companies are very well suited for private asset allocation, could that be private equity or private debt, so I think this is a structural trend and it will continue to develop in the near future.”
“Private equity has always thrived through periods of uncertainty”, underlines Hugh, who concludes stating that “the private equity investment model is based on a hands-on approach, an approach which aims at driving growth in a business through quick decisive decision making, so I am sure that private equity will come out of the next period of uncertainty in a stronger place. The focus it has put on value creation will see firm returns and strong growth in private equity companies.”
*Private Debt Investing: Benefits & Current Market Conditions, Saratoga Investment Corp.