KKR’s McVey takes ‘another swing at the plate’

Following a barrage of follow-up questions on his 2019 outlook, Henry McVey has issued a new note drilling down on private equity, China, Europe and the need for flexibility in asset allocation.

KKR’s Henry McVey is taking “another swing at the plate” after his 2019 Outlook provoked a deluge of follow-up questions and requests for data from clients.

McVey, head of global macro and asset allocation and CIO of the KKR balance sheet, put out his outlook in January in which he declared “the game has changed” and investors need to examine a different approach to asset allocation.

Allocations had to account for shifts from monetary to fiscal policies in governments, headwinds of higher input costs and higher wages, complexities across the capital structure and the increased domestic focus of major economies across the world. Indeed, periodic dislocations could create significant opportunities in 2019 for investors with a long-term game plan and the ability to buy complexity amidst uncertainty.

McVey’s team was inundated with follow-up questions and requests for data from clients and others seeking to dig deeper into the key macroeconomic and asset allocation issues that were laid out in the note.

“The note certainly has engaged our client base in ways we have not seen in some time,” McVey said.

In response, McVey’s latest note, “Another Swing at the Plate”, drills down on issues raised by clients and others about China, Europe, asset allocation and the need for flexibility.

Here’s what we learned:

1. Capital market arbitrage is critical

In the medium term, capital markets might be “stuck” between growth and financial conditions. Higher growth will bring tighter financial conditions with higher interest rates, and lower growth will mean margins and trade negotiations are under pressure.

Given these market conditions, flexible mandates across liquid and illiquid investments will help investors take advantage of periodic dislocations.

For its part, KKR has increased allocations to actively managed opportunistic credit and special situations and continues to be overweight on private equity by more than 300 basis points.

McVey believes private equity will perform even better in the current market cycle because the majority of alpha comes when market conditions are not so ebullient.

“Our strong recommendation is that allocators focus more on public-to-private deals than sponsor-to-sponsor transactions in 2019,” McVey said.

2. Private equity in Europe stands to benefit from market dislocations

For one, European public equity indices are significantly underrepresented in technology, business services and other key growth markets, and are overweight on cyclicals such as natural resources and financials that have challenges ahead. In comparison, top quartile European private equity portfolios are overweight in technology and business services and have demonstrated success investing in less cyclical industries such as healthcare and e-commerce.

Thus, performance spreads between European private equity and public equities could be higher than normal and PE will easily outperform public equities in the next five to seven years.

McVey believes corporate carve-outs will be an attractive place for private equity to be in Europe. These will require lots of operational intensity but can be acquired for multiples below the industry mean.

3. China is a concern for American companies’ ambitions

China started the process of shifting its dependence away from the US and other external markets after the financial downturn a decade ago. Indeed, China flows into the US real estate market have turned negative, and ownership of US Treasuries will shift from China toward US savers, resulting in competitive yields.

Importantly, as China internalises demand further, it is increasingly insulated from geopolitical tensions. Besides, it has made significant progress in higher-value added exports in technology and automobiles that pose threats to US economic interests.

CEOs of American firms are worried about tighter policy and regulatory issues; indeed, barriers and trade tensions have the potential to derail growth in one of the largest market opportunities for them.

McVey believes the shift in China’s strategy creates opportunities in logistics, including evolving supply chains that will benefit economies like Vietnam, Indonesia and Mexico.