July 2019

Thought For The Month

No doubt attracted by the historical performance, passive funds have increased allocation to private equity in recent years. Consequently there are numerous mentions of a ‘private equity
wall of money’ in the financial press. It is hard to know whether private equity investors truly are investment gods. Some studies suggest their long-term returns could have been generated by
investing in small cap equities and using leverage. However, that is irrelevant to where we are. Private equity has money to spend, relatively attractive equity valuations around the world of which to take advantage and incredibly low bond yields with which to leverage the deals.

In days of old, private equity often received a poor reception from both incumbent management and long-term shareholders. However, I wonder if times have changed. Management of PLCs
are now on the wrong end of much more intrusive behaviour from regulators and shareholders and may have convinced themselves that those jolly nice people from private equity are better
stakeholders (and will pay them more too). Meanwhile, shareholders in the receiving end of a bid for one of their holdings find it hard to resist selling a share which is trading 40% higher
than the previous night’s closing price. And they sell to the investors only too happy to accept the official bid price. Assuming private equity has some quality control, this suggests
they can build a portfolio of ‘good’ companies at a 40% premium to the market, leaving those companies most highly indebted, vulnerable to disruption or overly complex to the public market.

Of course, in days gone by at least a decent percentage of departing companies would be replaced by IPOs, but this market is on its knees. Investors have had enough of being offered those
companies which private equity have squeezed to within an inch of their life while companies looking to raise fresh equity seem more likely to wander into the arms of private equity than bother
with public markets.

A monthly commentary is, I’m often told by my marketing colleagues, supposed to conclude with a punchy summary or call to arms. If that’s the gig, I’m afraid I’m struggling. Private equity is already a large asset class and once it invests its cash it will be even larger. As a consequence, public markets will shrink further and investors may find the quality of their investible universe deteriorating. A longer-term trend to consider over the summer holidays.

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