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Magazine Issues » November 2022

Roundtable: Private equity in a new decade

With interest rates rising, entry price and valuations in private assets are going to be the most essential factors for returns. This is something not many people in the industry have experienced, our private equity panel is told.

Private EquityWilliam Nicoll, CIO of private and alternative assets, M&G Investments
Sam Tidswell-Norrish, Managing director, Motive Partners
Stéphane Pesch, Chief executive, LPEA (Luxembourg Private Equity and Venture Capital Association) 
Michel Degosciu, Managing partner & co-founder, LPX AG
Andrew Allright, Chief executive, managed accounts, State Street

Funds Europe – With interest rates rising across the globe, how do we expect this to affect private markets?

Andrew Allright, State Street – The story for investing in private markets is still very much intact. Asset owners still need diversification and want access to different asset classes. The recent Preqin survey expects a doubling of assets into the private markets industry in the next five years.

William Nicoll, M&G – This is the first test for the private assets markets for a while. From the supply side, the drivers for people not wanting to take the listed equity route, as they used to, remain intact. For the rest of private markets, banks are still de-levering and looking at their business models. I don’t see the long-term trends changing at all.

If Europe is going to look more like the US over the next decades – which has been true over the last 20-odd years – we’ve got a lot further to go. In the short term, we are seeing the end of the bull run, but there is no fundamental issue with the market. Lower rates were just coincident with the growth of the private markets, which came about because of a fundamental change in how the banks were looking at the world and strict regulation of public markets.

Stephane Pesch, LPEA – The private markets have done well in the context of low interest rates and have produced recurring and strong performance. Nowadays with increasing interest rates some effects like the cost of leverage, or valuations of certain assets, will need to be mitigated and dealt with. In any case, general partners (GPs) will be able to hedge their positions, they will scrutinise more specifically the debt maturities, and they will nurture longstanding lender relationships in the case of more debt-focused strategies.

Michel Degosciu, LPX AG – You have to differentiate the asset classes within private markets. For example, rising interest rates will definitely have an impact on venture capital investments because they are based on future cash flows that are being discounted to the present value. However, in the buyout sector, you are investing in existing companies that have a proven business model [and] positive EBITDA cash flows, so rising interest rates have less impact on the valuation.

We cannot expect interest rates to stay below zero indefinitely. It should be normal to pay an interest rate of 3-4% when you invest in a risky asset.

Sam Tidswell-Norrish, Motive Partners – We’re seeing a paradigm shift and the repercussions of 14 years of financial repression and money printing. Since then, it is the first time these variables have really come into play and it’s going to have a significant impact on valuation across every asset class, not just private markets.

The impact of the rising rates and inflation is going to be profound across all areas; different for different companies and structures, and especially painful for highly levered companies dependent on a much stronger economic backdrop. It’s going to be a while before those rate hikes get pulled back because inflation must be controlled.

For the first time in over a decade, entry price and valuation are going to be the most essential factors for returns. That’s something that not many people in our industry have had to prepare for. In fact, many people have done well by mistake, so it really is going to be a fundamental shift.

Knowing your context and having conviction in the assets you’re buying, with a true bent on value creation rather than a reliance on debt markets, is going to be a really powerful tool for the next five years. As a specialist, it’s a good place to be. You know you’re going to see the unique opportunities first, there are going to be opportunities where they didn’t exist historically, and ecosystems are going to be very important in uncovering those.

Pesch – The very important differentiators for the future will be the capacity to create real alpha – i.e, value creation – to implement operational excellence – including ESG – and efficiency at all levels, to build on the experience of the senior team, and to use savvy technology.

Nicoll – When you go from a position of excess amounts of money and it being ‘free’, to money costing something and not being in complete excess, then those strategies – capturing the beta of private equity, which is just to lever something up – clearly aren’t going to work very well.

With tough decisions being made around financing, we will see survivors come through that have shown superior expertise and an understanding of their markets that allows them to grow effectively. This is exactly the time you’re likely to see assets mispriced the wrong way for once.

Degosciu – We analyse listed private equity stocks, and currently see companies traded at discounts that can be compared to 2009. You buy the company at the stock exchange, and you get the private equity portfolio at a discount of up to 80%. This is ridiculous; they are financed, they have enough cash on their balance sheet, they are not in a situation that they have to repay debts. It’s really a time to invest now for value investors.

Tidswell-Norrish – Based on a few conversations, it seems that the most disciplined firms with great processes and governance are going to be in the strongest positions.