The Private Equity Renaissance, to the fall of Rome

1/4 of bonus conference insights

We are publishing some additional notes due to interest in the panels at the GPFO European Association Conference hosted this month at The Royal Society. We will be extracting and summarising some of the more salient points from each of the panels over the next couple of weeks for GPFO members and premium subscribers.

The first of which, and a segway from the recent splatter of private markets discussion (this will be the last for a bit…), will be focussed around the private equity panel discussion. The full recording of the panel is included at the base of this post along with information about the upcoming ‘Managing Capital Calls in the Family Office’ event.

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Short introductions before we jump in:

Our panel chair, and adding some European flair, Antonio Curia is a senior investment banking professional, coming from a legal background. Antonio has led private capital advisory at Wimmer Family Office since 2017. Wimmer Family Office is a London-based multi-family office.

Robert Sears - Robert is Chief Investment Officer at CapGen, running all aspects of investment across client portfolios, including asset allocation, portfolio construction, risk management, and investment research. Capital Generation Partners (CapGen) is a private investment office for families, endowments, and charities. With $3.9bn in AUM across 30 clients, making the average CapGen client portfolio ~$130m in size.

Blake Shorthouse - Blake joined KKR in 2014 and leads the Client and Partner Group’s Family Capital team in EMEA. KKR (if you don’t know…) is an investment firm that manages multiple alternative asset classes, including private equity, energy, infrastructure, real estate, credit, and, through its strategic partners, hedge funds with $450bn+ AUM.

Sweta Chattopadhyay - Sweta is the Head of Investments, Europe, at Moonfare. She leads the investment team with a global remit across Private Markets asset classes. She also leads Moonfare's global efforts within Sustainable Investments and Private Credit and is actively involved in developing Moonfare's co-investment capabilities. Moonfare offers family offices and other private wealth investors access to top-tier private equity investment opportunities with $2bn+ invested through the platform.

Sara Yates, CFA - Sara is an economist and former Global Head of FX Strategy at JP Morgan Private Bank who stepped across to working directly with family offices over 6 years ago. Sara advises Novastone Family Office a Swiss family office and Novastone Captial Advisors - which provides curated Private Equity style co-investment deal flow for Family Offices.

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Setting the scene, and some data:

The panel started with Sweta sharing the findings of the recent private markets benchmark survey, GPFO had conducted in partnership with Moonfare. A detailed write-up can be found here, and the full whitepaper here.

The Macro: Comments on what we are seeing in the private markets.

Robert - Some families want liquid, others want illiquid - historically we have weighted to illiquid [at CapGen]. Currently, I draw a parallel here between hedge funds in the 2000s. They did really well and navigated the crisis, which was centered around the .com bubble, and therefore peak hedge fund came [in the 2000s], but unfortunately, 2007/2008 not such great performance. I think we were coming to this period [in private markets], lots of demand, fundraising, good returns, lots of deal activity. 2021 was a good example of that [for private markets].

I think maybe there's a big element of the danger here, people rushing in [to asset classes], particularly in growth and venture, which was where a lot of the growth compared to the last 10 years.

Everybody rushed into growth and venture at particularly high valuations the last couple of years, and some people are going to be / have been burnt by that.

Blake - What we have seen this year, which is probably just very logical, is if you look at investment activity as a proxy for appetite, the private equity deployment from families, it's definitely slowed down.

Whereas in 2020, 2021 people were very much ‘risk-on’... they are now very much ‘risk-off’. Geopolitical risk, higher inflation and macro economic risks [are the drivers].

Sara - So for the family office that I'm working for, they've been very sold on private markets for quite some time. But the way we run the portfolio is we really have two portfolios, you have a liquid portfolio where we have a more standard allocation, which I wouldn't want to say 60:40, because I think that is a bygone age. And I think very much now it's all about moving to understand actually, what is a proper portfolio? What should you be holding? but certainly, that's where we would have equities, uncorrelated strategies, and hedge funds. And then a significant bulk of the assets are held in the nominee portfolio. And that's where we have our real estate, long-term credit funds, but also, in particular, search funds. And search funds are a very particular part of the private equity space, they are very focused on quality because what they're looking to buy are companies that actually tick all the boxes, they've got the current cash flow, they're not capital-heavy, they're in defensive sectors quite often. So not particularly cyclical, the major problem they're facing is the owner wants to retire.

Is 60:40 portfolio dead?

Sara - I remember when I was starting my career at UBS, it was very much based upon this model of 60:40. And you would have equities somewhere between about 50% and 70%, bonds would be somewhere between about 30% and 50%. And everything else was squeezed into what was essentially the cash bucket. So you'd have commodities, you'd have currencies, you'd have hedge funds, maybe even a bit of real estate, which feature in the private markets, barely even a tick on the box. And I'm really glad to say that things have changed, but they are changing slowly. And part of that is because I think investors’ mindset, there's still a lot of people who haven't really had the opportunity to become involved in private markets haven't been able to come up the learning curve, and are still very much focused on what can I buy, what's out there in the public markets that I can buy? I think that's a really difficult time at the moment. And I think it's incumbent on all of us who work in finance to really help people understand how to rethink investment portfolios, how to better judge what you need, because there is an illiquidity premium that you have to consider when you're investing in an illiquid market. But there are so many options. And when you're looking at someone's portfolio, it's very unlikely that they need to have access to all that money all the time. So it's a sensible strategy to be locking some of it up. And particularly in things like private equity or other strategies. There's also now a growing secondary market, which is adding liquidity.

I think we don't need to be constrained to what was probably an anomaly in portfolio construction when the 60:40 was invented. And now we can start thinking about actually what exists? How can we best mix these asset classes to deliver the rest of the return and risk profile we want? And just get rid of the shackles of 60:40?

Robert - It's something we've been preaching for quite a while, is 60:40 is dead, you need alternatives. And I think the big part of that is, I don't think it's dead in the sense of a lot of investors are still, whether it's 60:40, or not, whatever the percentage is, it's still pretty much equity / bond or some variation. So I don't think that's ended yet.

It was a product of an age of interest rates falling for 40 years, and we're fundamentally in a different regime. So you do need a different solution.

So that's the core of it. And it's certainly been the case this year. I mean, this has been the worst year for US equity and bonds, let's say balanced portfolio, in the last 100 years, bonds have really sold off, and equities sold off at the same time. So it is likely to end worse than 1931 or 1969. It's a really bad year [for a traditional balanced portfolio], we've sort of seen the proof in the pudding.

To counterpoint, because I very much agree with most of it everything moves in different directions and depends on pricing. So the fact interest rates have gone up as much as they have now, bonds are a lot more appealing now than they were at the start of the year or last year. So on a short-term basis, there will be a comeback. Each time there's a recession, there will be that comeback, and bonds will, in the end, do quite well, even if we're in for a period of long-term rising inflation, which would be really bad for long-term investors to invest in bonds. The long-term case for holding bonds is still pretty poor. But each time there's a recession, there could be this comeback for the 60:40.

On the private side. I agree, I think for investors that can take the illiquidity, definitely it's a good piece of the portfolio. But it's more how are you going to get the extra return? I don't think in terms of diversification, particularly, it's an extra return from active involvement in the company’s operations and improvements. There is an extra return from being able to take control hold for a longer period. But it's not diversifying your risk. It's still equity risk in the end. So in that 60:40 model, you can think of it as replacing some of your public equity risks, but you're not diversifying and protecting yourself against broader risks. So definitely there's a big opportunity set now for your public companies.

Different approaches to private markets

Sweta - Investors are all different so it is important to understand risk preference, liquidity requirements, and asset bases hence there are a diverse set of private market strategies available to investors to meet these different needs. Where investors are in the journey of building their portfolios is also an important factor.

Sara - one of our core interests is search funds, quite a unique way to access the private markets. [A primer here on search funds from Stanford Business School] - watch the full recording below for the detail on the program (circa 35mins in).

Blake - Focus on what you can control; operational improvement, don’t use excessive leverage, avoid commodity price risk if you can, and think about portfolio construction. Instead of trying to time the market, we try to deploy all of our funds consistently. Where we made mistakes, eg. in 2005/2006 vintages we deployed too quickly, too pro-cyclically, then stopped deploying in the financial crisis and focused on dealing with problems in our portfolio companies. We apply a lot of common sense, and use deep resources to improve operating businesses - we try to think like industrial owners rather than just financial owners.

Is liquidity the main concern and challenge for family office private markets investing?

Sweta - liquidity, and lack of expertise, the universe of private markets are large and diverse. How family offices invest in private markets is also diverse, from direct, to funds, to co-investment. Each of these strategies requires different expertise, resources, and involvement. A lot of this comes down to the in-house team and advisors, making sure you are adequately resourced.

Robert - A lot of this comes down to cash flow. If you are setting up programs for family offices and private capital providers, you get calls (on committed capital) and you get redemptions. Not stretching yourself so when all the capital calls come at once, you can manage it. [Thanks for the segway into the session next week!]

We are hosting a session on Managing Capital Calls in the Family Office on Wednesday 30th November at 10:00 GMT.