Podcast transcript: What “the art of the possible” is for PE

15 min approx | 22 January 2021

Winna Brown

I’m really pleased to welcome back to the show Andres Saenz, EY Global Private Equity Leader. Andres, thanks for joining me today.

Andres Saenz 

Thanks for having me.

Brown

In the NextWave Private Equity paper, we spend time exploring not only the current trends that are shaping PE, but we also step back and use our imaginations to envision scenarios of potential futures for private equity. And, Andres, I thought it would be fun and interesting for our listeners if we shared a little more about the “art of possible.” Are you game to go on that journey with me?

Saenz

Yeah, absolutely.

Brown

What I really found exciting about what we did here is that we kind of let our imagination go, and we didn’t really have any bounds as we brainstormed these scenarios. Can you share why it was important to bring to life our point of view in this way?

Saenz

We wanted to look at what needs to happen now to succeed not this year or next year, but in 3, 5, 10, 10+ years. When you have success, and private equity, as an industry, has had a huge amount of success, it can lull a sense of urgency around change. We think things may look pretty different in a few years, such that you really do need to act now to survive and thrive. So I think pushing the envelope in this way is a helpful exercise in terms of what are the things you need to start doing now. 

Brown

The first scenario is one that we called the democratization of investing. Can you explain what this scenario is?

Saenz

Yeah, it’s a mouthful, but democratization of investing: think new platforms that allow investors to commit as little as $1 to private equity. These are retail investors, investing relatively small sums, that can participate in the private equity universe in a way that they haven’t been able to do so before. 

You’ve got new fund structures combined with online trading apps; brokerage platforms, again, to allow ordinary investors access to the same functionality; and investment types previously reserved for pensions and endowments and foundations. So that’s kind of the thought process behind that one.

Brown

When I think of that scenario, two things come to mind. One is technology and the technology that’s needed to be able to efficiently deal with such small investments of $1, to do that efficiently. Where do you think we are in terms of the capability of technology to do this?

Saenz

Well, I would say even before technology, one of the biggest barriers has been regulatory. The good news is there has been nice progress in broadening access. It’s becoming easier for accredited investors to invest in PE. There’s important developments in trying to create access to 401k type vehicles. You have real barriers around structurally; these are long-term investments. It’s not easy to get liquidity, etc., but I think there’s real progress being made and these structures in place to be able to do this.

Brown

So what you’re saying is that if the regulations open up, it allows regular people to be able to invest their money in ways that previously were only available to big funds?

Saenz

Yeah, that’s right, and I think that’s when you’re going to see the first thing that you mentioned, which is technology, become critically important — the ability to have the digital capabilities that came to larger financial services firms, in terms of the investment tracking and the reporting, all of the mechanisms that are required to deal with thousands, maybe millions, of individual investors.

I think the other one that becomes critical, related to something we just talked about, is this idea of purpose and transparency. You’re competing for dollars and now you’re competing for dollars across a very diverse consumer base.

When you start to think about branding and you start to think about competition and what we stand for, people are going to be able to select private equity funds not just based on returns but also based on what they’re trying to do and what is their strategy, and what do they stand for and what impact they are trying to create, and that’ll be pretty interesting.

The other implication that it may have if you think about the investment in technology and the importance of competing for these dollars, is it may continue to harden the bifurcation between larger firms and smaller firms — with larger firms being able to make a lot of these scale investments to access these investor pools and having more of a focus on their purpose, their transparency, being able to communicate that message, and you may have midsized firms that continue to play on a different scale.

Brown

You think of private equity as this elite group, only for certain people, but this now kind of opens it up, right?

Saenz

A previous incarnation of this, I think we were referring to this as the reutilization of private equity investing …

Brown

Yeah.

Saenz

… but I think democratization of the investing I think captures it in that sense, where you are truly providing access to differentiate the returns to a much broader group of people. And it’s not just institutions and organizations that may themselves ultimately lead to returns for individual pension holders, for example, but as a private individual, you’re able to dedicate capital to this kind of asset class and benefit from the return. I think that’s something that a lot of people would truly find appealing. 

Brown

Our next scenario is the first entirely AI-run fund. And we’ve envisioned that it’s going to raise over $20 billion in capital. I have to say this is my favorite scenario, so maybe you can give a little bit more of an outline on this one.

Saenz

Yeah, think of a PE firm and grab some of the top Silicon Valley names for towns and resources, building a first fund driven entirely by artificial intelligence and data analytics, pulling data from thousands of sources, and algorithmically originating deal ideas, and monitoring portfolio companies, and exits, etc. So that’s kind of the thinking on that one.

Brown

I’ve shared this with you but I have to say this, the reason I love this one is it makes me think of this futurist state, matrix-like world, where from one end of the life cycle all the way through to the end, you’ve got machines running private equity. Now that’s clearly a future state, but kind of cool. It tweaks at the imagination. What do you think? How far along down the lines are we?

Saenz

This one is definitely farther out, at least in its purest form. You think about the industry today: it is very human-driven, very, sort of, organic, in that way. And you are seeing investments in AI for point solutions; but if we use the baseball analogy, in terms of the rise of sabermetrics and analytics, I think we’re at the pre-Billy Beane stage. I mean, it’s very, very early in terms of people thinking about the industry in this way and not thinking of the industry in terms of human-driven, decision-driven, Rolodexing, etc.

You ask the question: could it really happen? How do you think about fund-raising in an AI world? How do you think about the role of bankers for sourcing? How do you think about negotiations and interacting with portfolio CEOs? I think those are all interesting questions.

Brown

Yeah, and I think that one of the things when people say, oh, it’s just not possible, you’ll always need people. I think the reality is, if you look back over the last 50 years, there are so many jobs and roles that have evolved as a result of technology. They’ve become less focused on repetitive, non-value-adding tasks and have become more pointed and focused on strategic, deep-thinking-type tasks that add more value. And maybe this is what we’re talking about, right?

Saenz

In the end, you’re trying to generate better returns and create more value. And if AI can lead to better decision-making on which deals, how much to pay for a deal, what to do when you have a portfolio company, and how do you create value, if that leads to better answers, this will absolutely get adopted. People are going to look for that edge. I mean, again, the baseball analogy around sabermetrics and the growth of that in baseball, that’s actually pretty interesting.

And you think about, again, it has implications across the deal life cycle, from generating better investment ideas, to sourcing deals and figuring out what could be available or in need of capital, doing better diligence, and you could enhance and optimize a template by which you would value a deal and benefit from the wisdom of hundreds, if not thousands, of prior deals.

You look into the portfolio getting visibility and oversight of individual portfolios, but not think of them as the group of data points that gives you a better sense of where to invest and where to create value and what levers you want to pull on any particular opportunity and then all the way to exit.

What are the best exit options? I mean, in each of these, which today are really human-driven with the aid of technology? It’s not inconceivable that these would be technology and AI-driven with the hand of the human guiding it through.

Brown

The extreme example is probably a little while away into the future. We are seeing, today, in all aspects of business where, as you said, technology is being leveraged to do a multitude of tasks to get efficiencies and to get better outcomes. And we’re using people and their brainpower in areas where they really can add more value.

It’s just when all of these different points of technology start to come together and interconnect, end to end, that we’re going to start to see the bigger picture of how AI can really drive a private equity ecosystem.

Saenz

And I think, for me, what’s interesting is not to think about this scenario as 110% AI-driven, but really pushing AI to a deep point, but then the interplay between AI and talent. And when you have the maximum AI with talent as the enabler, I think you get the best of both worlds. And so you get the proper interpretation of the data. You get the managing of the relationships across stakeholders, whether it’s investors and banks and entrepreneurs, on the basis of the insights from the data that you get the best possible human negotiations, again, based on the data analytics that are there.

So you think about the AI really informing the strategy, but then ultimately executed by the talent that’s in the organization. And I think that interplay is still pretty far out, but I think it’s something that people would find profoundly interesting if it helps them to make better decisions and generate better returns and create more value.

Brown

The talent is always going to be needed to compliment the AI and the technology, but also what’s going to need to happen is consideration of the types of talent that’s going to be needed within private equity to make this AI-run fund work.

Even though I could talk about the matrix all day, we can move on to our final scenario. This scenario is a bit different. This one a little bit more nearer term. We’ve called this one the “move over Walmart, PE firm becomes the largest employer in the world.” So what do you think? Let’s explain that one a bit.

Saenz

This would be, in some ways, a great success for the private equity sector but also increases the level of responsibility, and you can envision sort of the regulatory bodies scrutinizing the duty of care that PE firms have more heavily around employees and portfolio companies and the general public, and firms proactively having to demonstrate their contributions to the workforce in the future. I agree. I feel like we’re closer to this one.

And, if you look at the data, 4 out of the top 10 private employers in the world are private equity firms (if you take the full employment of their portfolio companies). So, mathematically, it’s getting there. But, philosophically, not quite. I don’t think many people are aware of the big funds’ footprint in the way that I’ve stated it, and I don’t think the firms necessarily act as their full stewards of that size of a workforce, but it is changing.

Brown

Just on that though, if I think about private equity, I think of private equity as being a lot more nimble. So as it becomes a bigger and bigger force in the world and regulatory bodies have more scrutiny over them, is it going to change the dynamic of the sector?

Saenz

I think it will. I think if we go back to these levers that we think are disproportionally important these days are on talent and digital and purpose; I think this one affects all three. Obviously, from a talent perspective, I think you have to think about what value the private equity firm is adding to a portfolio workforce and across all the portfolios, from an employee engagement perspective, from an upskilling perspective. I mean, there’s whole sorts of dimensions where it is our view that the private equity firm is a ton of value to add beyond just what company management can do and especially leveraging some of this data.

And so I think that’s where digital comes in: where are there insights in other platforms that can be used across the portfolio to benefit individual employees in a way that, if that company were solely owned and not part of a private equity complex, maybe they wouldn’t have access to some of these things? So there’s just a lot of things that could be done on the talent side with digital enablement, and I think, in the end, it’s going to be part and parcel with their purpose and transparency.

I think it’s hard for a private equity firm to get to the point of long-term value in the way that we talked about it earlier on this podcast, without having a clear view of that human element, and having that human element be inclusive of the very large portfolio workforce that they have. In some ways, you know, if you look at this scenario in the way that it’s been written around top private employers in the world, almost by necessity, you need to have a very clear purpose and very clear transparency around your goals.

Brown

As you outlined that, it made me think of another interesting point. Two private equity firms operate the same. Some currently take a very hands-on role in the portfolio companies and the investments they make, and others make the investments and they retake the strategy, but then they let the companies run their own show until they eventually sell them.

What we’re saying now as private equities evolve their long-term values and their strategies and they have their purpose more defined, it feels like they’re going to have to take a deeper hand in the investments they make and not just stay back once they’ve set them down their path. If there’s going to be more regulatory scrutiny, they’re going to have to act a lot more hands-on and more like a corporate vs. the traditional private equity model. What do you think about that?

Saenz

On the one hand, I think there will be different philosophies about how proactive the private equity firm is and the stewardship of the portfolio workforce; but, having said that, I think everybody is going to have to move more in that direction. Some of it because the “have to” to your point about regulatory scrutiny, public scrutiny, etc. Some will want to, and I think this again comes back to this idea of creating shared value together; that, in the end, taking a more active role — we’re talking about better employee engagement, better learning and skilling — all of these things should, in theory, lead to a better company, which should also lead to better returns and better outcomes, financial and nonfinancial.

So my sense is that people will want to do that. And, again, if we’re going back to how, on the basis of how private equity firms compete, this is one of the levers that’s going to make a difference in the medium to long term. People will go there.

Brown

So Andres, having just gone through these future state potential scenarios, what is the call to action we should be looking for in 2021?

Saenz

Today, private equity firms have their strategy, some form of differentiation. They have an investment outlook that’s derived from that strategy and an operating model that enables it. So, in some form or another, folks can continue down that path, and I think, given the growth of the industry and the fundamentals of the industry, it will continue to be wildly successful in 2021.

What’s interesting for us is, again, 3, 5, 10 years out, the industry is going to look different. What will your strategy be, and how will it be different on the basis of that? Does it change your point of differentiation? Does it change your investment playbook? How does it change your operating model? And, hence, how do you get from here to there? What are the gaps? And what do you need to start doing now if you’re going to be successful in 3, 5, 10 years that’s different from being successful in 2021? How much are you going to push your purpose and your transparency and embed it across your organization? How close to this fully shared value creation idea of long-term value do you want to get to? How much are you moving on your talent agenda? How is that evolving, from leadership, to succession to the four generations that are currently in the workforce, to D&I? Where are you embedding that, and how are you doing so? And what are you going to do this year to move you in that direction? And then, finally, on digital, what are going to be the transformational investments that you make in digital across your deal life cycle, across the back office, into the portfolio companies, etc.?

There’s always been sort of these elements of private equity strategy. I feel like purpose and transparency, talent and digital haven’t been as central, and, as such, I think the industry maybe is a little bit behind where it should be, but I think our call to action for 2021 is we have to get on these things, if these firms are going to succeed and if these firms are going to be the powerhouses that they are today in 3, 5, 10 years.

Brown

Andreas, any final words before we wrap up today?

Saenz

No, thanks for having me. I think, again, the industry is at a really interesting time and congratulations to you, Winna, and the team for our yearlong venture into these podcasts and look forward to the content and insights that we can generate over the next year as well.

Brown

Thanks Andres. It’s been a load of fun, and my thanks to the team as well. Looking forward to the next year.

Saenz

Thanks Winna.