The long and short of it
Learn the top five trends industry leaders are currently focused on, plus what's coming down the line
The year so far has taken many twists and turns, challenging both LPs and GPs to consider how best to capture opportunities in private markets. So what are industry leaders thinking about in the short term? And, given the long time horizons in private markets, what developments will we see beyond that?
Here are the top five trends for today and another set for what’s coming down the line.
1) Macro considerations are moving centre stage
Private markets, with their long-term focus, has tended to focus more on the micro risks and opportunities than the broader picture, but the volatility we are seeing today means that macro issues have risen up the agenda.
“Global investors are paying much more attention to tail risks,” says Jake Siewert, Managing Director, Head of Public Policy & Political Risk at Warburg Pincus. “With the disruptions today, we have to be more attuned to issues such as the geographic implications of supply chains, for example, and of geopolitical considerations. It all makes for a complex picture.”
Patrick Severson, Senior Managing Director, Co-Head of Vista Foundation Funds at Vista Equity Partners: “We are spending a lot more time on geographic, political and economic risks today,” he says. “We are predominantly software investors and the market for talent is global, but we have to assess very carefully where, for example, we establish R&D centres and other parts of the business. It can be an opportunity, but you do have to factor in that there will be more scrutiny around these decisions and you need to conduct long-term analysis.”
2) The scramble for talent is intensifying
The pandemic has significantly disrupted the labour market as older workers have taken early retirement and as immigration was halted through lockdowns. There was already a scramble for talent in many industries – and it’s only becoming more intense. “Where are all the workers?” asks a senior GP. “The rising cost of labour and increasing turnover are significant challenges today. All GPs now need to be a lot more proactive around labour and not just assume it is there.”The same is true for the industry itself – and this is helping to drive the diversity and inclusion agenda. “Private markets generally have not been known for diversity in their workforce, but this is changing, in particular as LPs are asking for this but also as the need to find new talent increases,” says David Chiang, Chief Investment Officer of Pritzker Family Foundations. “The venture capital side of the industry has done better than others in diversity, equity and inclusion as well as around firm culture, but we are now seeing private equity and other areas of the private markets space recognising that they need to create a culture that’s reflective of a changing workforce and economy.”
3) Business building is back
Some say it never went away, but now the market has changed, there are plenty who admit it was just too easy for some players to make money over the past few years – cheap debt meant that leverage could drive returns, while multiple expansion meant it was hard to lose money. Not any more. “The asset class has evolved,” says Adam Howarth, Partner and Co-Head of Portfolio Management at Partners Group. “Private equity 1.0 was built on leverage, 2.0 was a beta trade – now we’re in 3.0 and building businesses.”And cost-cutting has also had its day, says Matt Cwiertnia, Partner and Co-Head of Private Equity at Ares Management. “Private equity built a reputation for cost-cutting over an extended period of time,” he says. “Our view is that game has largely played out and focus has shifted more to growth. Today, value creation through growth predominates the market – it’s all about the top line.” Howarth agrees. “There is no cap on how much you can grow a business,” he says. “But there is a cap on how much you can cut before you damage your enterprise. We will see a paradigm shift towards value-add and alpha oriented managers and away from beta-driven strategies.”
Private equity 1.0 was built on leverage, 2.0 was a beta trade – now we’re in 3.0 and building businesses.
4) LP-led secondaries are back
GP-led deals have dominated the headlines for the past two or so years as they have reached parity or even exceeded LP-led volume. And while GP-led deals continue apace, this year has seen something of a rebalancing. The first quarter was busy for LP-led deals, but the public market falls and the invasion of Ukraine then took their toll. “LPs were already overallocated and then the public markets faltered,” says a secondaries player. “The secondary market shut down because buyer and seller price expectations were just too divergent. Yet once the Q2 numbers came out, there was a flood of deals in September. We’ve seen an incredible rush of transactions. We’ve had sellers come to us saying they need, say, US$300 million of liquidity and here’s US$1 billion of assets – what would you like to buy?”That said, these are not the firesales of yesteryear’s crises as many LPs have built some flexibility into their allocation targets. As a result, they are able to take more nuanced positions on their portfolios. “If you are looking at secondaries, you have to ask whether deploying the capital you free up will generate better returns than you will get on a mid-life fund where you have high conviction and which has already generated strong returns,” says Sean Olesen, Investment Officer, Cornell University – Office of University Investments. “Is it an upgrade, or does it present different or additional risks?”
5) Co-investments are becoming more efficient
The scramble for deals over the past few years may well have left a lasting legacy. Even though processes may proceed at a slightly more leisurely pace over the coming period than many have become accustomed to, both GPs and LPs have refined their co-investment modus operandi to speed up decision-making and allocation.“Sponsors are increasingly doing the work upfront to understand the process, timing and capability of each of their potential LP co-investors well ahead of any deal opportunity,” says Aditya Fontana-Raina, Principal, Private Equity at StepStone Group. “It may seem painful to do this so early on, but it leads to much more efficient processes and helps prevent eleventh-hour miscommunications. This is also helping LP co-investors get in early on conversations. This means LPs can gain access to work in progress information or iterations on underwriting. Co-investors appreciate this open access information and it allows them to give an indication of their interest levels more quickly.”
1) LPs will engage in even more active portfolio management
This has been the case for many years already, but the pace is picking up and will continue to evolve. “The maturity of the asset class is helpful for all of us, especially around secondary deals that are evolving to ensure that GPs and LPs have the flexibility to fine-tune their exposures,” says David Chiang, Chief Investment Officer of Pritzker Family Foundations. “Secondary deals may once have been taboo, but that has changed and there is far more recognition, for example, that CIOs need to adjust their portfolios. The maturity of the secondary market provides opportunities for change and new partnerships. I’m not sure that GP-led transactions are the future for the majority of deals – that would be too extreme – but continuation funds are not going away any time soon and the opportunities will continue to be there for a few years to come.”
And this will lead to further innovations in private markets. “The whole GP-LP relationship is changing as the 10-year fund life period is no longer taken as set-in-stone,” says Cwiertnia. “LPs are increasingly asking: where are my IRRs? Do I need to get into new relationships? Do I need liquidity? It’s much more dynamic and will become more so as retail investors come in. Five years into a fund, initial LP bases may well look very different.”
2) Collaboration between industry participants will increase
LPs have become increasingly sophisticated in private markets and are therefore more able to add value to partnerships with GPs
There is a growing recognition that many LPs can add value for GPs beyond providing capital and this could result in some far-reaching changes. “LPs have become increasingly sophisticated in private markets and are therefore more able to add value to partnerships with GPs,” says Chiang. “Most GPs today appreciate LP involvement in areas such as co-investment deal flow and through continuation funds. And the more LPs and GPs talk to each other, the greater the appreciation for what each is trying to solve for. I see this as an opportunity to think ahead and bring about change in the industry, whatever form that takes. The world is changing and the industry needs to keep ahead of that change.”
Stephen Moseley, Managing Director at Wafra agrees, citing collaboration between LPs as a powerful force. “There is a significant opportunity for LPs to team up,” he says. “We’ve seen this with the GP seeding strategy pursued by Capital Constellation and that form of co-operation has relevance to other areas of private markets. GPs and LPs can also work closely together to change the private equity model – it’s currently an outlier because, for example, it lacks price differentiation. Other industries routinely adapt pricing, yet the ‘2 and 20’ model persists regardless of how well or poorly a manager is doing.”
3) Energy transition will create decades of opportunity
Cleantech and renewable energy are clearly part of the solution to move the world’s economies away from fossil fuels, but LPs are increasingly turning their attention to existing assets, spotting opportunities to help them make the shift.
As Ethan Levine, Head of Real Assets and Sustainability at Commonfund Capital, explains: “There is an unintended problem with LPs simply drawing a red line through what they will invest in. There are ways for investors to put money behind assets that are currently seen as high emitters, help them decarbonise and that could make an even greater impact on reducing carbon footprints.”
This is the approach CPP Investments is taking. “We are of the view that energy transition is not about divesting what you own,” explains Suyi Kim, Global Head of Private Equity at CPP Investments. “If you put a conventional energy producer on the market, someone else is going to buy it. Our position is that we will work with companies to transition them and reduce their carbon intensity. As a pension fund, we are investing for future generations and we see our role as patient capital to make the transition happen. Yet we also firmly believe we will generate strong returns by focusing on this.”
4) Returns will be lower that we’ve become accustomed to
There is an expectation that private markets will continue to outperform public markets, but that returns will inevitably fall over the coming period.
“Private equity has been the highest performing asset class for the past 15 years,” says Kim. “But historical performance doesn’t indicate what we’ll see in future. Repeating the absolute returns we’ve seen in recent years will be a challenge because we’re coming out of an extended cycle that has been a perfect environment for private equity. Interest rates were low, leverage was cheap and a large part of returns were generated through multiple expansion. It’s pretty simple maths that the interest rate hikes will lead to lower multiples.”
“I don’t think we’ll enjoy the same returns we’ve had for the past ten years because it has been an extraordinary period,” says an endowment investment officer. “But we do still believe we will achieve an illiquidity premium – returns will be lower, but they will still outperform public markets. We’re not expecting multiple expansion, but rather contraction. That will eat into returns, but we’ll also see this in public markets.”
Repeating the absolute returns we’ve seen in recent years will be a challenge
5) Technology will transform private markets
“Just as with all other sectors, technology will change the way private markets firms operate and invest,” says a seasoned LP. “This has the potential to change the way firms conduct due diligence, analyse investments and manage increasing numbers of portfolio companies. This will also transform reporting to LPs.”
And one of the biggest shifts from the deployment of technology could well be the democratisation of the asset class as platforms make it easier for retail investors to access the market.
“The development of digital marketplaces is helping attract new individual investors,” says Stephen Brennan, Head of Private Wealth Solutions at Hamilton Lane. “Technology providers can now offer them access to ten-year life funds.” And there is more to come. “Technology is transforming access to private markets,” says Steffen Pauls, Founder, Chairman and CEO at Moonfare. “What will blockchain do to the industry?”
"The development of digital marketplaces is helping attract new individual investors"
Stephen Brennan, Head of Private Wealth Solutions at Hamilton Lane
