Inflation may be the major risk out there today, as Blackstone‘s president and chief operating officer Jonathan Gray said in April, but the private equity industry appears confident it is well-placed to weather a rise in costs of goods and services.
That was the overwhelming takeaway from our gathering of thoughts on the issue this week when we looked into how the PE industry plans to tackle inflation. You can read the piece here, including comments from EQT chief executive Christian Sinding, Bain Capital co-managing partner John Connaughton and Partners Group‘s head of portfolio management Americas Adam Howarth.
Three main themes stood out. The first is that PE is well-positioned to deal with rising prices by making thematic investments in companies that are long-term winners. Yes, prices may rise in the short to medium term, but by picking high-quality companies and investing for the long-term, the nature of private equity’s active ownership model means sponsors can afford to take a long-term view. “There is always some sort of macroeconomic or geopolitical disruption to consider,” said Partners Group’s Howarth.
Second, portfolio companies can simply pass costs on to consumers to mitigate the effects on profit margins. The extent to which companies can do this in practice will of course vary by sector and subsector. Investors will want to get ahead of any purchase price changes and anticipate which companies are not affected by higher input prices, and for the companies that are, ascertain whether they have the pricing power to pass costs on.
Third, the industry isn’t losing sleep over how inflation will affect fundraising. With total private capital assets under management at $7.4 trillion as of the end of last year and expectations it will grow to $13 trillion by 2025, according to Morgan Stanley estimates, investors continue to be hungry for private markets strategies. As Coller Capital’s latest LP survey found this week, the net balance of investors planning to increase their allocations to alternative assets is now higher than at any time since the global financial crisis, and LPs are keen to continue allocating to private markets, even as they believe the perceived risk to returns has risen “significantly” over the past 18 months.
So, is the industry all fine and dandy on the inflationary front? Not quite. As a leading economist told us this week, while economic growth is coming back and there are profitable companies to be found, multiples are very high by historic levels across all asset classes.
“Investors are, understandably, concerned that if central banks start to raise rates in a significant manner, it could all come crumbling down,” the economist said.
With the US Federal Reserve this week saying it would bring forward the anticipated date of its first post-pandemic interest rate rise to sometime in 2023, the test for those who really have invested in strong management teams of high-quality companies in non-cyclical industries will be just around the corner.