To Infinity and Beyond: The State of Private Equity

This post originally appeared on RaudlineEtienne.net on Jan. 22, 2018.

Private equity funds soared to new heights in 2017 and show few signs of slowing down in the new year.

According to a report by Preqin, 921 private equity funds reached a final close in the last year and secured $453 billion in investor commitments: a new fundraising record. In fact, as more data becomes available, Preqin acknowledged that the actual amount raised could increase by as much as 10%. A major catalyst of this fundraising were mega buyout funds of $4.5 billion or more—they secured an impressive $174 billion in investor commitments last year—as well as North American and European-focused funds.

Notably, the previous fundraising record was set in 2007 as 1,044 funds secured $414 billion in investor commitments. This context makes 2017’s fundraising that much more impressive since fewer funds were able to secure an even larger supply of capital, thus highlighting the strength of private equity as an asset class today.

Funds also flew past another milestone in 2017 as the amount of dry powder, or committed but undeployed capital, exceeded $1 trillion for the first time. Despite this tremendous reservoir of capital, a report from PitchBook found that 52% of private equity professionals plan to raise a new fund this year with the hope that any new funds will raise at least as much as previous funds. GPs and other private equity professionals must feel an incredible level of confidence in their products and potential in order to raise additional funds, and furthermore, this also signals confidence that investors will continue to commit to new funds despite mountains of existing dry powder.

Additionally, the PitchBook report also noted that 70% of GPs do not intend to offer “special incentives,” including fee breaks or co-investment opportunities, to investors who make early or large commitments, which indicates GPs and funds still hold most of the cards in fundraising negotiations.

Private equity’s recent successes appear to validate predictions by experts that the asset and wealth management (AWM) industry will grow spectacularly throughout the coming decade. In an earlier blog post, I discussed a report by PwC profiling the future of the AWM industry, which predicted that total assets under management will practically double from $84.9 trillion in 2016 to $145.5 trillion by 2025. With private equity setting new fundraising records and accumulating unprecedented amounts of dry powder, PwC’s vision for the future of AWM seems to ring true.

Advertisements

The Future of Finance: Purposeful Capitalism

This post originally appeared on RaudlineEtienne.net on Aug. 15, 2017.

Evolution and the capacity for innovation on a large scale are cornerstones of the CFA Institute’s Future of Finance report. Throughout the four possible scenarios that it envisions on the horizon for the worlds of finance and investment, the CFA predicts revolutionary developments in market forces, communication, social organization, and other areas. These themes of innovation and transformation reappear in the CFA’s fourth and final proposed outcome in which the rise of a new, purposeful capitalism reshapes finance along moral, ethical, and more client-centric lines.

As I discuss more thoroughly in a previous blog post, the CFA analyzes a series of megatrends and posits four scenarios to describe how the financial world would respond: fintech disruptionparallel worlds“lower for longer,” and purposeful capitalism. In the latter, the CFA suggests that firms will become more conscious of all stakeholders and seek to redefine value propositions by placing more emphasis on trust and nonfinancial considerations.

The impetus for such soul-searching, according to the CFA, comes from a recognition of limits and changing forces. The report notes that as firms acknowledge the interconnected nature of finance—particularly when “viewed as an ecosystem”—they will stress the importance of trust in business and look for ways to demonstrate integrity. Additionally, concerns over systemic issues like resource scarcity and shifting demographics will prompt firms to operate via the principles of sustainable development.

Furthermore, as trust and sustainability come to play a larger role in the financial world, firms will need to find ways of aligning their investment strategies with these values. As a result, pursuing the greatest possible returns or profit maximization may no longer be the supreme goal for many firms who hope to make ethics a key element of their brand or strategy; the report points out the paradox of holding tobacco and health care stocks as an example of this. In fact, the CFA notes that these tradeoffs will represent a large part purposeful capitalism’s development.

Ultimately, firms that embrace purposeful capitalism will pay attention to the needs of broader constituencies that include clients as well as the public at large. Ethical business practices, like the adoption of corporate social responsibility (CSR) or ESG investing, will take center stage at financial institutions, which will also prioritize leadership and diversity initiatives.

To read the CFA’s full Future of Finance report, click here.

Private Equity or Pension Fund?

This post originally appeared on RaudlineEtienne.com on Aug. 9, 2017.

Imitation has been called the sincerest form of flattery, and if so, pension funds around the world are beginning to show admiration for the private equity funds they have so often invested in. As a recent article from Bloomberg Businessweek explains, in the face of sluggish returns and increased operating costs, pension funds have started acquiring companies and investing in private debt themselves, bypassing the private equity funds and alternative asset managers to whom they typically outsource these investments.

Pension funds, particularly in Canada—such as the Ontario Municipal Employees Retirement System (OMERS) and the Ontario Teachers’ Pension Plan (OTPP)—are forgoing private equity funds to directly acquire small and mid-size businesses. OMERS recently purchased a minority stake in the pet care provider National Veterinary Associates, for example, while OTTP outright purchased PetVet Care Centers several years before that. Although both examples are drawn from the same industry, they illustrate the larger trend that pension funds are now prepared to buy businesses or private debt rather than investing in private equity funds, which would have simply invested in some of these companies and their debt anyway.

Additionally, pension funds are assembling their own teams of experts to identify investment opportunities in sectors like private, middle market loans. These new hires empower pension funds to make their own investments while furthering their transformation into quasi-private equity funds.

According to the Bloomberg article, there are several advantages to this strategy, although the primary benefit is increased returns. Pension funds get to improve their returns by avoiding paying asset management fees to private equity funds—and since private equity’s fees have remained relatively high owing to their spectacular returns of late, this could represent a significant savings.

While this trend has been good news for pension funds so far, private equity funds may need to adjust their own practices if it continues. The Bloomberg article suggests that as the private equity’s stellar returns begin to cool, more and more pension funds will exit to avoid paying fees on lower yields and instead begin to directly invest in private debt and acquire companies on their own; this may prompt private equity funds to begin to lower their fees.

The Future of Finance: “Lower for Longer”

This post originally appeared on RaudlineEtienne.net on Aug. 9, 2017.

Although interest rates in the United States inched higher earlier this summer, around the world, rates remain low as countries try to spur economic growth. The strategy of keeping rates low in order to encourage growth is not new, but according to the CFA Institute, it may typify the future of the financial industry as continued low interest rates lead to low returns, anemic growth, and a climate of political and social instability.

In a previous blog post, I profile the CFA Institute’s Future of Finance report and it’s four prognoses of how the financial sector may evolve in the coming years: fintech disruptionparallel worlds, purposeful capitalism, and “lower for longer.” In the last scenario, the CFA predicts that perennially low interest rates and other factors—including excessive debt in both the public and private sector and aging populations—combine to prolong the period of weak growth that has followed the global financial crisis.

According to the CFA, low rates will bring about an abundance of global capital and low returns, which will prompt continued intervention by central banks even as those interventions begin to have diminishing impacts. Governments will be largely be unable to respond owing to crippling public debt.

Meanwhile, as average lifespans become longer, corporations and public entities alike will have a harder and harder time meeting their pension obligations, which will lead to pension crises and even pension poverty. This will simultaneously increase pension costs and damage corporate values, further complicating the process of economic recovery and growth.

Under such conditions, the world of finance will respond by deemphasizing innovation since the abundance of capital will mitigate the incentive to develop new products or practices. And while markets may become more efficient thanks to more advanced technology to assist in due diligence and price discovery, they will also become less liquid as capital migrates to fixed assets like real estate and infrastructure.

Financial service providers will also need to cope with a higher level of regulatory scrutiny. The CFA forecasts that lower returns will cause firms to increase their marketing efforts in order to attract new customers; consequently, this will attract a higher level of oversight from regulators and thus additional compliance costs, further shrinking firms’ margins.

To read the CFA’s full Future of Finance report, click here.

The Future of Finance: Parallel Worlds

This post originally appeared on RaudlineEtienne.net on July 5, 2017.

In many ways, the world is more connected today than it has ever been. The flow of ideas and information across the globe takes only seconds thanks to the proliferation of internet-enabled devices, while people and goods can quickly and easily traverse the world thanks to free trade and open border agreements. However, despite these contemporary trends, the CFA Institute forecasts that the near future may be characterized less by an interconnected world and more by parallel worlds as fissures open up across our society and our institutions rush to adapt.

The CFA’s Future of Finance report, which I discuss in a previous blog post, describes four possible scenarios for the financial world of tomorrow: fintech disruption, “lower for longer,” purposeful capitalism, and lastly, parallel worlds, in which different strata of our society—men and women, rich and poor, rural and urban, and so on—interact with society in different ways, prompting greater personalization and ease of access to financial services.

In the parallel worlds scenario, the growth of social media suddenly allows people and groups who previously existed on the margins of society to engage more fully in political and financial worlds. As a result, social media primarily becomes a forum to express discontent with elites and institutions by the people who did not benefit from what the CFA describes as the “golden marriage” of capitalism and democracy. This popularizes anti-establishment and anti-globalist views, which in turn fuels an ascendant authoritarian nationalism around the world.

Meanwhile, as the “haves” continue to make advances in healthcare and education relative to the “have-nots,” people begin to engage with society differently based on the social group they belong to; these social stratifications exist along lines of gender, class, political inclination, and so on.

The financial world—according to the CFA—will adapt by emphasizing personalization and simplicity in their offerings. Owing to the popularity of social media and widespread internet access, consumers will come to demand a wider range of digital financial options, which will cause financial services to become less expensive, more abundant, and significantly easier to access. Therefore, opportunities to innovate will come in the form of developing infrastructure and new channels to engage with financial services rather than actually unveiling new services.

To read the CFA’s full Future of Finance report, click here.

The Future of Finance: Fintech Disruption

This post originally appeared on RaudlineEtienne.net on June 2, 2017.

From media to retail to healthcare, new technologies have triggered a wave of disruption across dozens of established industries. Taxi operators, for example, must contend with digital upstarts like Uber and Lyftthat have made it possible for passengers to call a car and driver at the push of a button, and some industries—such as travel and photography—have been rendered all but obsolete by new technologies. While finance is also being affected by technological innovations, today’s advances may be the tip of the digital iceberg: In fact, the CFA Institute predicts “fintech disruption” may define the financial industry of tomorrow.

In a previous blog post, I discussed the CFA’s recent Future of Finance report, which analyzes several global megatrends and proposes four scenarios for how they might transform the world of finance; the futures they envision are entitled “parallel worlds,” “lower for longer,” “purposeful capitalism,” and of course, fintech disruption. Fintech—which describes a range of technologies that can deliver financial services to consumers—is already a powerful force, and its influence can be seen in the rise of robo-advising, which uses algorithms and large data sets to automate many elements of financial planning.

The CFA bases its prediction for widespread fintech disruption on several existing technological megatrends, like the proliferation of IT-enabled devices that make it possible to receive constant updates about investments in real time, but it is particularly interested in big data and machine learning. Big data allows firms to upload and store massive amounts of information and access it from anywhere via cloud technology, which can be analyzed virtually instantly with the help of artificial intelligence and complex algorithms.

In the coming years, as data storage becomes more efficient and computing power increases, the CFA predicts that fintech devices and programs will be able to scan enormous quantities of data to deliver fast, accurate, and hyper-personalized insights and recommendations to investors. But identifying technological advances is only part of the picture: How does the CFA envision fintech affecting the financial industry itself?

There are several potential avenues. In one scenario, entrant firms could deploy new technology with greater speed and efficiency than more established, entrenched firms, allowing these new players to “outflank” the competition by driving down costs and winning over the tech-obsessed Millennial generation. Conversely, established firms could develop fintech fluency—perhaps by purchasing fintech firms altogether and assimilating their services—to drive down costs as well as attract and retain customers; additionally, by using fintech to offer more personalized services while enhancing customer services, firms could step into the role of concierges for clients.

To read the CFA’s full Future of Finance Report, click here.

Data Mining and Private Equity

This post originally appeared on RaudlineEtienne.com on May 24, 2017.

Today’s private equity sector is thriving, but that doesn’t mean that firms have stopped working to develop new competitive advantages. Many such efforts focus on how firms can cut costs or enhance returns, but another avenue firms should consider involves taking advantage of the breadth of raw data available online to strengthen and streamline their due diligence processes. As a recent Forbes article points out, this data can help private equity firms “increase the speed and reliability of insights” that shape their decision making and make it easy to determine prices for various assets.

Incorporating digital data mining into due diligence is part of a broader trend of digitalization in the private equity and financial services industries. Firms have availed themselves of a wider range of digital tools and technologies to improve outcomes and entice customers while also increasing their own efficiency. For example, as the Forbes article indicates, in the case of due diligence, the labor intensive and time consuming process of identifying and analyzing a firm’s strengths and weaknesses can now be completed within a few days using data easily obtained via the internet, which saves firms time and money.

There are a number of specific areas where digital data can offer private equity firms important insights. By studying online customer reviews, a private equity firm could learn more about a target company’s products or services, its relationships and standings relative to competitors, and more. Additionally, the authors of the article–all of whom are leaders of Bain & Company’s private equity practice–discuss an example where they “combined online data with store visit observations for the potential buyer” during their due diligence of a sporting goods retailer to evaluate the efficacy of the company’s organizational structure; they found that, in comparison with other firms in the industry, the retailer in question had a larger proportion of managers and support staff than store employees.

Data mining can also improve outcomes for due diligence by analyzing relevant social media posts from customers, e-commerce data, geographic presence, and more.

This approach is not without its limits, however. Analyzing such large data sets could require firms to acquire new software that can process the sheer volume of information. Furthermore, this practice would not replace traditional methods of due diligence like customer surveys. But for firms that are looking to make digitalization a competitive advantage, the Forbes article offers a promising path forward by proposing data mining as part of enhanced due diligence efforts in the world of private equity.