What to do when things get tough: are you ready for 2020?
Are you ready for 2020? Private equity and venture capital trends you need to know as we head into the next decade from investor views to economic outlook.
What to do when things get tough
Are you ready for 2020?
As we wave goodbye to the 2010s, we look ahead at what the new decade could bring for private equity and venture capital, through the lens of the experts at SuperInvestor 2019.
As we approach the seemingly imminent end of the economic cycle, there are plenty of concerns over its impact on the private markets. Is it really all gloom and doom? Hear from the likes of industry heavyweight David Rubenstein and watch our panel recordings from the event.
Focusing on the LP perspective, how has investor appetite changed and how will it be involving with the market conditions? As ESG and impact investment move increasingly front of mind, how can GPs adjust their agenda?
Read on and get ready for 2020 and beyond.
What should we expect for 2020?
The rise of the private markets
How to defend against the risky market
Inside the minds of LPs
What's directing LP allocations?
Aligning the stars for LPs and GPs
Louise Boothby, Partner, Coller Capital
Ilona Brom, Managing Director, Wilshire Private Markets
Peter Cornelius, Managing Director, AlpInvest Partners
Dana Haimoff, Managing Director, Portfolio Manager, J.P Morgan Asset Management
Ilja Hauerhof, Senior Product Manager, Private Equity, S&P Global Market Intelligence
Raphaëlle Koetschet, Head of Funds Investment, Caisse des Dépôts Group
Elias Korosis, Partner, Hermes GPE
Giovanni Orsi, Managing Director, Private Equity, Funds, PSP Investments
Gideon Rachman, Chief Foreign Affairs Commentator, Financial Times
Marc Roijakkers, Senior Fund Manager, Alternatives, Blue Sky Group
Andrew Sheiner, Founder & Managing Partner, Altas Partners
Helen Steers, Partner, Head of European Investment Team, Pantheon
Daniel Winther, Head of Private Equity and Infrastructure, Skandia Life
What should we expect for 2020?
The trends and pitfalls of the private markets
With the industry enjoying a golden period, what’s set to shape the agenda as we head into next year? The Financial Times’ Gideon Rachman and The Carlyle Group’s David Rubenstein considered the factors at SuperInvestor 2019, outlining their views on the economic and political environment, and what that means for the industry.
While the economy and the private equity industry are in good shape, there are some risks that could send it off track as we head into next year and beyond.
That’s the view from SuperInvestor 2019 in Amsterdam.
Gideon Rachman, the Financial Times’ chief foreign affairs commentator, focused his address on the trade tensions between the world’s two largest economies, and on the potential rise of what he called the “populist left,” while David Rubenstein, co-founder and co-executive chairman of The Carlyle Group said he is optimistic about the future, while also being mindful of some potholes.
After many consecutive years of unprecedented success for private equity, there are questions about how long this period can continue as prices rise, China and the US continue their disputes and the global economy slows. While it is almost inevitable that the bull market will end at some point, how both general partners and limited partners respond will define their future.
“The industry is in reasonably good shape,” Rubenstein told the conference. “People think the industry going to produce pretty good rates of return, more and more money is coming in. But there’s no doubt that we do have some issues we have to address, they are related to image, related to the high amount of dry powder and return expectations which look pretty high.”
Since we’re now more than 10 years into a growth cycle, Rubenstein said recession would come at some point but that he didn’t think it would happen in 2020. Instead, The Carlyle Group sees low growth, of just below 2% in the US and a lower rate in Europe. China has been growing at around 5.5%-6% and is likely to continue in that direction, he said.
On monetary policy, the US Federal Reserve will probably hold back on cutting interest rates again so that it has some ammunition left if there is another recession, the European Central Bank is likely to continue its strategy of supporting the economy and China won’t do much more easing on the policy front.
One of the key questions Rubenstein said he gets asked is on national debt levels.
“There is a lot of debt, maybe too much debt,” he said. "It is manageable in the current climate of low interest rates, but should rates start to rise it could become more problematic," he said.
The economy is going along at a reasonable pace, it’s not likely to go into recession territory. We don’t know whether something unforeseen could happen but generally what we see on the horizon is manageable.
- David Rubenstein, Co-Founder and Co-Executive Chairman at The Carlyle Group
Rachman focused his attention on the relationship between the world’s two largest economies – China and the US – which he described as “very troubled.” The two countries have been embroiled in a trade war for almost 18 months and Rachman said that even if there was some sort of deal done, the underlying tensions would continue to simmer.
“The nature of the relationship has changed quite fundamentally and we’re not going back,” he said. “There will be an increasing separation and how far that goes is the biggest theme in politics.”
The rivalry isn’t just based on trade, he said, but a more wide-ranging strategic rivalry that could last for 20 years. “Technology is at the centre of the debate,” he said. “It’s not just business, it’s a question of national security.”
Rubenstein was more sanguine, saying it’s in the interests of US President, Donald Trump, to get a deal done before the election in 2020.
Gideon Rachman, Chief Foreign Affairs Commentator at Financial Times, joined us for an exclusive interview to discuss the economy disruptors as we head into 2020.
Both speakers underscored the political risks. Rachman said that alongside the trade war, the changing nature of populism was another major theme, specifically the rise of the popular left, which could threaten capitalism and private equity.
“More things are coming that spell challenging times ahead,” he said. “It’s going to be a challenging time for global finance.”
That could have a direct impact on private equity, with US Senator Elizabeth Warren, a candidate for the Democratic Party nomination, already attacking capitalism and planning to introduce legislation to regulate the industry more forcefully.
Other political factors that may be destabilizing are the outcome of Trump’s impeachment trial, the UK political turmoil and exit from the European Union, tensions between China and Taiwan, and the protests in Hong Kong.
But what of private equity?
“If the economy does slow down it will be more challenging for the existing deals we have in the portfolios,” Rubenstein said. “That will be challenging in terms of exits and returns.”
Prices in the industry are high, pushed up in part by low interest rates, and that could limit returns. There’s also a lot of unspent cash looking for a home, with dry powder estimated to be well in excess of $2 trillion, which will probably keep upward pressure on prices.
On the positive side, investors have cash at their disposal to redeploy and private equity returns have consistently outperformed public markets, making them attractive. And having a longer duration allows the industry to ride out political fluctuations, low growth and low interest rates.
“The economy is going along at a reasonable pace, it’s not likely to go into recession territory,” Rubenstein said. “The geopolitical events are manageable. We don’t know whether something unforeseen could happen but generally what we see on the horizon is manageable.”
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The rise of the private markets
What are the implications for investors?
As private market performance overtakes that of public markets, what is the impact on the industry?
Is this dynamic shaping the sources of capital with an appetite to invest?
We hear from our panel of experts at SuperInvestor 2019:
- Ilja Hauerhof, Senior Product Manager, Private Equity, S&P Global Market Intelligence
- Helen Steers, Partner, Head of European Investment Team, Pantheon
- Peter Cornelius, Managing Director, AlpInvest Partners
- Elias Korosis, Partner, Hermes GPE
How to defend against the risky market
Capital deployment and bottom line protection
Are private equity firms becoming more defensive in this increasingly risky market environment?
How do you maintain performance in a downturn?
Maintaining rigorous processes to find high-quality assets is one way to bolster performance in a downturn.
The right culture and the right set of checks and balances and controls are also important when things get tough, according to a panel of experts moderated by Carlyle Group’s Ruulke Bagijn at SuperInvestor 2019 in Amsterdam.
As the macroeconomic environment becomes riskier, general partners need to weigh the context of a changing backdrop against the opportunities arising from the proliferation of technologies and disruptive forces, and focus on finding the areas where the most value generation is taking place.
“It’s all about placing our capital on the right side of this watershed,” said Kurt Björklund, the co-managing partner at Permira. “Backing industries that have strong long-term thematic growth. You have to be really careful about how you think about fundamental value when you invest.”
As for whether they feel defensive, the panel explored what would happen if there was a downturn or recession. Slowing growth makes for a difficult environment and makes analysis even more important to determine the strength of the business and whether it can survive.
However resilient the businesses you back are, you still have the problem that corporate expenditure is going down and consumer spending is going down. You never want to be hamstrung by debt.
- Kurt Björklund, Co-managing Partner at Permira
“If a business is starting to come off, you need to be clear whether that is structural or cyclical, so it could bounce back,” said Robert Lucas, Managing Partner, CVC Capital Partners. “That’s critical to deciding whether to hang on or exit the investment.”
Chris Caulkin, Managing Director & Head of Tech for EMEA at General Atlantic gave the example of a deal that his firm had stuck with through a slow patch – the pan-European job portal StepStone. Sticking to their belief that the company would survive the cyclical factors at play, his firm benefited from structural changes when advertisers switched to online, away from traditional magazines or newspapers.
Even so, the panellists said it was important to be mindful of the debt levels and how appropriate they are for the economic cycle, leaving room for manoeuvre should things get tough.
“However resilient the businesses you back are, you will still have a macro effect,” Björklund said. “You still have the problem that corporate expenditure is going down and consumer spending is going down. You never want to be hamstrung by debt.”
Control and culture
In a downturn, factors including how much control a firm has over and investment and the personalities involved can become more exposed and more important.
CVC Capital Partners’ Lucas said having the right internal culture and the tools to take action were more important than the level of absolute control.
“When things get tough you want to have a culture internally that encourages people to bring forward issues early,” he said. “You can have all the control in the world, but if you haven’t spotted an issue and got in to it early, then you’re in trouble.”
For Caulkin, being a minority investor isn’t an issue. It’s not about being passive as a minority investor, it’s about the bigger picture, he said, and that means making sure the due diligence is done properly and there is real, genuine alignment among the investment partners.
There are great opportunities in the European tech sector, and more of those businesses are going global, creating even bigger opportunities to invest.
Andrew Sheiner, Founder & Managing Partner at Altas Partners, explores what can trigger a downturn and the precautions managers need to take to keep their ships afloat.
The panel discussed the relative merits of investing for different durations.
Björklund said it is very hard to forecast out beyond 10 years, so constant reassessment is needed. “Often something happens that you can’t predict,” he said, as he advocated a model where 20 assets were put into one fund, and then 15 or so are sold at a certain point, leaving the core 5 that are known really well to perform into the future.
CVC Capital Partners’ Lucas said his firm are “constantly reassessing” the assets in its longer-term funds and that gives flexibility.
“In past downturns a lot of companies emerged as better competitors,” said Matt Cwiertnia, Co-Head of Private Equity, Ares Management. “The ones who got really hurt were the lower-quality companies that were already losing share. The numbers didn’t add up.”
So, in the current climate, GP success hinges on a quest for high-quality assets, trying to be on the right side of structural change, being able to act when times get tough, and avoiding conflicts of interest. When slowdowns take hold, it’s even more important to get the basics right.
Inside the minds of LPs
Where does investor appetite lie in the current market?
What are LPs looking for beyond financial returns? As they become more selective and involved, how can GP cater for this evolution in investor relationships?
We hear from influential LPs who are shaping the debate and putting sustainability, disruption and equality on centre stage.
The relationship between private equity general partners and their limited partners is always evolving, and as we look ahead to 2020, it may be set to change even more.
LPs are taking a more active role, seeking strong, long-term partnerships with their GPs and putting an emphasis on areas that once got little attention. These include alignment, personal relationships, dealing with downturns, planning for disruption, and embracing environmental, social and governance considerations.
Delegates discussed these factors, and more, at SuperInvestor 2019 in Amsterdam, agreeing that ESG will continue to be a focus, with LPs increasingly seeking data and metrics that show the impact their investments are having.
How does your company view impact investment?
- It's what we do!
- It's an integral part of investment plan
- It's what we are looking to do more and more
- What's impact investment?
"Double bottom line"
“What we ask our GPs now is to invest with a double bottom line,” said Raphaelle Koetschet, Head of Funds investment at Caisse des Dépôts Group. “The financial outcome and also the impact. It’s to have all that in mind.”
Culturally this can require a shift. GPs now need to dedicate resources to meeting the needs of their LPs, and the key to success can lie in linking their rewards to performance indicators based on ESG metrics. Other LPs use score cards to monitor how the GPs they work with are performaning in this area.
Maurice Klaver, an investment manager in private equity at PGGM, said his firm focuses on broad themes where they want to see a positive trajectory or impact, these include climate, healthcare and food security. Progress is being made and we are measuring it, he said.
While some GPs may find the additional pressures a burden, the LPs agreed that ultimately companies that take these issues seriously will be more profitable, and that will convince any GP who isn’t already on board to get involved.
In many ways, the private equity industry, like others, is learning as it goes. Knowledge can be gleaned from the public markets, the delegates said, where some companies have suffered or been marked down after having poor ESG. To counteract the risk of this happening, better and more consistent frameworks need to be established.
For me it’s not about the rainmakers, man or woman. It’s about the constellation, the social construction of the team.
- Heiko Bensch, Senior Portfolio Manager, Alternative Investments at Ampega Asset Management
Getting to know you
Achieving progress in this, and other areas, hinges on strong relationships between LPs and GPs. Face-to-face meetings and building a good rapport over time are key. Having a good relationship means being able to have difficult conversations when necessary, for example when strategies are changed, or returns don’t come in as expected.
Alignment was a theme, with the LPs saying they want to see GPs backing their deals with their own money, going in alongside other investors. This was seen as a critical path, something that’s not just about data, it’s also about the length of relationships, and really understanding the thought processes and how the returns are being generated.
“We want to explore the motives of why people are coming back to the market,” said Imogen Richards, a partner at Pantheon. “We want to ensure they’re aligned. It’s not just about one stage of due diligence, it’s about continual due diligence and long-standing relationships.”
Raphaëlle Koetschet, Head of Funds Investment at Caisse des Dépôts Group, explains why GPs need to know that it is not an either/or choice between financial returns and sustainable investment.
Building a pipeline
Knowing your GP has a strong supporting team and a pipeline of good people and good deals is important. Some LPs expressed concerns about fund size, which has crept up, and about the amount of dry powder that some GPs are sitting on, these are both factors that can change the firm’s culture.
“For me it’s not about the rainmakers, man or woman,” said Heiko Bensch, Senior Portfolio Manager, Alternative Investments at Ampega Asset Management. “It’s about the constellation, the social construction of the team.”
To mitigate any potential downturns, the LPs said they like to invest with partners who are also thinking about slower growth before it happens and modelling the potential impact of a recession as well as making sure a buffer has been built in in case valuations are hit.
This also applies to technological disruption – with no areas set to be untouched by digitalisation, LPs want reassurances that their GPs are thinking about it, planning for it and building it in to their investment decisions.
Fully integrated ESG is now seen as a must-have, rather than a nice-to-have. This focus has developed alongside investors’ realisation that taking such factors into account can also contribute to value creation. Among the challenges the industry faces as it continues to fund with ESG in mind is that it needs to coalesce under an agreed framework for measurement,
As the industry matures, the non-financial side will become even more important.
“ESG has to be involved,” said Yolande van den Dungen Portfolio Manager, Alternatives SPF Beheer. “In the end, that is because we believe the underlying companies with good ESG, that are thinking about it and improving it, are better companies.”
What's directing LP allocations?
The economic cycle, ESG and more
How are LPs allocating their capital, and how are they viewing the market as we move into 2020?
How are LPs adjusting their portfolios given where we are in the cycle, and what strategies are being adopted to protect returns?
Are ESG and impact the main driver for their investment decisions?
Here to answer the questions is our panel from SuperInvestor 2019:
- Louise Boothby, Partner, Coller Capital
- Giovanni Orsi, Managing Director, Private Equity, Funds, PSP Investments
- Dana Haimoff, Managing Director, Portfolio Manager, J.P Morgan Asset Management
- Daniel Winther, Head of Private Equity and Infrastructure, Skandia Life
Aligning the stars for LPs and GPs
It's not just a relationship, it's a partnership
Alignment was a buzzword at SuperInvestor 2019, seen as essential for good working relations between a private-equity fund and its investors.
So how is the relationship between the GPs and LPs evolving, and what might we expect to see in the future?
The relationship between a fund and its investors is critical in the private equity world and those relationships have been changing in recent years as the industry matures and as the economic situation changes.
Where once LPs would take a relatively passive role, they’re increasingly seeking more and more information, playing an active role and in some cases taking on more risk.
Having a strong strategic alignment was the overarching theme – with the delegates agreeing that allying interests, building trust and making sure that performance was in some way linked to pay outs, were important factors in any relationship.
Ilona Brom, Managing Director at Wilshire Private Markets, talks to us about the key characteristics they look for in GPs and why the LP-GP relationship today is a true partnership.
Skin in the game
As GPs grow larger and diversify their operations, it can be important for them to show their commitment by investing alongside their LPs. As firms seek to diversify their offerings by launching new strategies, the risk is that they stray too far from their core capabilities and stretch performance. Putting in their own cash can help alleviate some of these concerns.
“Investors want to make sure that the GPs have skin in the game and their own personal capital invested in their projects,” said Michael Rees, the head of Dyal Capital Partners. “If you’re raising a big fund, you need to put in a big commitment.”
One such area of diversification is long-duration funds, with some GPs launching vehicles with a life longer than the industry’s traditional 10-year fund model. The panellists said they were open to longer-term solutions, as long as there were no nasty surprises, the strategic alignment was there, and all parties were agreed on the aims of the fund.
“I would like to know from very early on that it’s a long-term thing,” said Michael Lindauerm, the global co-head of Private Equity at Allianz Capital Partners. “I don’t want to find out after 10 years that something is turning into a long-term thing. This is one of the complexities.”
Other areas of diversification include launching multiple product lines, embracing lower hurdle rates, using credit-lines and GP-led fund restructurings.
This proliferation of activities can be positive, since launching products and strategies can present new projects and challenges to existing staff, exciting them and creating ways to retain them, as well as giving the firm broader reach and potentially creating additional returns for the LPs.
Even so, one of the risks is that the diversification stretches the GP too thinly.
We’re looking at team, we’re looking at track record and we’re looking at market opportunities as well. And when the stars don’t align, that’s a warning sign.
- Naoki Ohta, Managing Director at Barings
“When we get really worried is when we see an awesome fundraising machine that just raises money and then invests, invests, invests,” said Przemek Obloj, Managing Director, PSP Investments. "But ultimately, we are open to new ideas and fundamentally, we want to invest behind the best investors.”
It’s about hunger and opportunity for Naoki Ohta, a managing director at Barings. His firm tries to capture managers and opportunities before others and look for the alignments there.
“We look for alignments where we believe we can capture manager at their hungriest,” he said. It’s also about assessing the wider opportunity. “We’re looking at team, we’re looking at track record and we’re looking at market opportunities as well. And when the stars don’t align, that’s a warning sign.”
Beyond the numbers
Trust and the quality of the relationship with the individuals was a key theme, and there was a sense that in those areas, there is now a focus on the future – for example, assessing who is likely to do well in the next recession or downturn – rather than on track records or past numbers.
“We are looking for a forward-looking alignment,” said Obloj. “What is the incentive structure, how is money being made, how is it being distributed.”
Trust also plays into the distribution of incentives – asking deeper questions about the guaranteed fee income and the potential and carried interest that might become available. It’s no longer just about looking at the monetary aspect, although obviously this is key, but also about the motivation of the individuals involved.
Marc Roijakkers, Senior Fund Manager, Alternatives, Blue Sky Group explores how the LP-GP relationship has changed as macroeconomic factors come into play.
Ultimately there was a broad agreement that each situation is unique and needs to be assessed individually to make sure it makes sense for both the GP and the LP.
“When we make these investments now, we want to make sure that we’re aligned in wanting to see that money put back to good use within the firm,” said Rees. “We don’t have a say in what these GPs do - it’s up to them to decide. We just want to be there to help with capital and share some lessons learned.”
For Lindauerm, it’s all about assessing the liquidity options and being ready to accommodate requests. Some situations can feel “too opportunistic,” he said.
While the relationship between LPs and GPs seems to be evolving all the time, what’s clear is that both sides are embracing the changes and looking to form better strategic partnerships that go the distance. Done well, it can be a mutually beneficial relationship where both sides offer each other solutions.
“I really like to see this type of innovation in the industry, where we begin to offer solutions that look different,” said Dyal’s Rees. “Innovation is a positive.”
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