Private equity, investing in uncertain times

Interview published in Finanz und Wirtschaft, 6 July 2022

The 2008 financial crisis was followed by a ten-year stock boom – but, despite appearances, these were not good times for the stock exchange. Over the last two decades the number of listed companies in the USA has shrunk by around a quarter. At the same time, says Jean-Pascal Porcherot, Lombard Odier’s newest Managing Partner, value creation has shifted from the stock exchange to the privately-held sector.

From 2008-2018 the median annual return of private equity funds was 19.5%, a trend, Porcherot says, that will remain significant for investors. With inflation high, fears of a weakening economy, and a world beset by war and geopolitical conflicts, investors need to hedge their bets. Alternative investments – including hedge funds and a mix of different private assets – are the right choice in the face of uncertainty.

During the financial crisis it became apparent that these long-term investments were less crash-prone than freely tradable equities. In recent years, Porcherot says, “progress has been excellent. When you take into account all the arguments in favour of the asset class, it remains attractive.” In the face of rising interest rates, however, investors have punished listed private equity providers. Partners Group, the leading private markets firm in Switzerland, has lost more than 40% of its market value this year, while US competitors Blackstone and KKR (Kohlberg Kravis Roberts and Co.) have also lost more than the broader market.

Boundaries blur

Despite this, the outlook for the sector as a whole remains positive. According to Porcherot, the industry’s invested assets have grown from USD 2 trillion to USD 10 trillion since the financial crisis, and as recently as April of this year the industry was expecting the pace of growth to continue. A recent study by S&P Global pointed to the fact that there is still plenty of “dry powder” even though 2021 saw a record number of private market transactions, and anticipated similar capital-seeking conditions this year.

Public market investments often bring with them the temptation to “time the market,” to attempt to catch the perfect moment to enter. With private market investments, Porcherot says, this temptation is reduced. “You can’t invest in just one vintage, you have to be in it for the long-term. Moreover, it is important to diversify. Many focus on private equity, while we advise clients to diversify their portfolios by investing in other private assets such as private debt, infrastructure and real estate.”

In practice, the line between private market investments and publicly tradable investments is becoming blurred. This development is driven by the fact that increasingly large parts of the valuation expansion are happening prior to a potential Initial Public Offering. For example, Porcherot explained, “Airbnb was a more interesting investment as a private company than it is now.”

Today, private market investments are usually “alternative investments” – Porcherot’s speciality. But, instead of seeing private equity as separate investment vehicles, in the equities space, Porcherot says that a time could come when such investments could be spread between privately held and listed shares, and that he is “curious to see how people will view this in ten years.”

Promoting innovation

Private equity investments are sometimes criticised as carrying extra risk, particularly in light of recent expansive central bank policies and the end of a phase of quantitative easing – but Porcherot only partially accepts these objections. “Yes, there is a lot of money available,” he says. “It is true that valuations have risen substantially, maybe even too much in certain sectors – I wouldn’t disagree. That makes fundamental analysis of companies with a long-term perspective, and choice of the right manager, all the more important.”

In contrast to the dotcom bubble of the late 90s, however, Porcherot believes that today we are seeing business models that work. He also believes that high valuations support innovation by favouring those companies that force the established players to question their business models. For instance Tesla, whose “impact on the electric vehicle sector,” he says, “is very interesting in this sense.” The same paradigm can be seen across sectors and industries. Porcherot explains, “I invested in a solar farm in 2009. Many people told me that the business model was not sustainable because it was only supported by state subsidies. If you fast-forward to 2022, the price of solar panels has fallen considerably thanks to economies of scale, making these business models attractive.”