Podcast transcript: What 2020 and beyond looks like for global private equity

18 min approx | 1 Jan 2020

Winna Brown

Hello and welcome to the EY NextWave Private Equity Podcast.  In our series, we explore the impact that private equity can have on the economy and society capturing insights from industry thought leaders and private equity practitioners from across the globe.  I’m Winna Brown from EY and I’m your host.  Hello and welcome.  In this episode, we will explore the trends that are impacting the private equity industry, both today and in the foreseeable future.  I’m really delighted to have Andres Saenz with me today.  Andres is EY Global Private Equity Leader.  Welcome to the show, Andres.

Andres Saenz

Thank you, Winna.  Delighted to be here.

Brown

Andres, as EY Global Leader for Private Equity you’ve worked with and advised a number of global PE complexes, as well as locally based PE in countries outside the US.  This, I’m sure, has given you a very unique perspective on the sector.  What are the most interesting ways that you’ve seen PE evolve over the past three to five years?

Saenz

Well, even if you go back the last 20 years, there’s been a period of tremendous growth for private capital from its roots in the ‘70s and ‘80s and the buyout in venture capital spaces.  Private capital has expanded dramatically in both scope and scale.  The funds have gotten larger, the investor pool has broadened, and the largest players have transformed themselves into fully diversified alternative asset managers, and for good reason.  PE has continued to deliver very strong returns for its investors.  However, I do think there are a number of disruptions that have come along with this grown in the more recent years. 

I think, first, there have been record levels of fundraising without probably the equivalent rise in targets and ways of deploying that capital.  So, in turn, this causes the price paid for these assets, the multiples to rise.  I think beyond the core investment platform and the need for value creation, new strategies in asset classes like sector specific investing, growth capital, impact investing, long life funds, we’ve got things like private credit, real estate, and infrastructure, they’re all expanding the definition of what it means to be a fully diversified alternative asset manager.  And then you have other players coming in, sovereign wealth funds, pensions that are doing direct deals increasingly moving into the traditional PE space.  And they introduce a measure of disintermediation by gauging in-house staff to source, manage and harvest their own deals.  So, there are investors in the PE funds, but also looking to have a direct play in the arena. 

Beyond all these things, of course, you have digitization, technological change broadly that is now challenging traditional business models and redefining industries, sectors, and functions at a pretty unprecedented pace and scale.  PE is certainly not immune to these forces.  Now, this can be both a threat and an opportunity, but it’s not surprising to me how much investment in the tech sector has grown in recent years.  And with this I think you can add digital technologies broadly, AI, robotic process automation, data and analytics.  These are all changing the way that PE firms do business and the ways they create value.

Brown

Wow, that’s a lot of interesting change.  So, let’s explore a little bit of what I heard a little bit deeper.  Let’s start with technology.  How is technology actually impacting the way PE complexes are doing business?

Saenz

If you look back even just five years ago, PE was really behind the curve when it came to technology.  The industry was extremely reliant on manual processes for the front office, the middle office, and the back-office functions.  And it really hasn’t been until recently that it has been willing to make some of those investments in technology, as it’s recognizing the need for change and seeing some of the possibilities that are enabled in terms of origination, value creation, and other aspects of the model.  By the way, this also leads to changes in the way the people work and is impacting PE firms’ talent agendas.                             

According to our PE CFO Survey, for example, 75 percent of the CFOs that EY surveyed said they wanted their teams to spend more time on technology.  And the potential is huge.  Emerging technologies will help PE firms harness data more effectively, again, to originate, to conduct diligence, to manage their investments.  Right now, large data sets are being created that are making actionable data available for private companies as well as public companies.  Things like social media signals, web traffic, hiring trends, media monitoring, and alternative data sets such as satellite imagery and geolocation data.  These can all help PE firms gain a competitive advantage.

Brown

So Andres, if we connect the dots here, do you think that technology has been an enabler of value creation, perhaps maybe prompting more clever and cutting edge ideas helping to bring to life the application of out-of-the-box thinking on ways to add value to a business?

Saenz

Sure.  The baseline is PE has been in the area of value creation for at least the last decade.  And with valuations as high as they’ve been for years now, they’re looking for operational value creation more than ever in order to ensure they can keep the returns they want to get for their investors over the coming decade.  And, yeah, cost cutting is always part of the playbook for most companies, but now you’re seeing really a focus on putting any number of levers around growth in the topline.  Sales growth, new customers, new products, new channels, salesforce optimization, pricing levers, and any sort of IT-driven value enhancers.  So, in general, I’d say tech maybe used to take a back seat to team, and process, and strategy.  Some firms would wait two to three years before going out and implementing a technology piece, but now it has really changed.  They address it immediately and you see the operations team really sort of follow from that.  The advisors that work with these private equity firms are becoming an increasingly important part of the firms’ strategy for driving returns.                        

Years ago, there were senior executives with industry experience, etc. Now, as you try to bring this technology piece in, there’s a wide range of models spanning various seniority levels, skill sets, backgrounds, and objectives.  Right now, the industry has about 30% more operating resources than it had just four years ago, and again, these resources are being involved earlier in the cycle and are increasingly specialized, and again, with an emphasis on this technology piece.

Brown

So, the focus on value creation has definitely impacted the mix of talent that private equity has hired and will need to hire into the future to be competitive.  So, as I reflect on the generational change in the workforce as millennials mature into managerial and executive positions, what’s unique about their value set that PE is starting to recognize and respond to?

Saenz

Yeah, effectively attracting and harnessing the right talent is absolutely at the top of the firms’ agendas right now.  If you look at the top of the house, many have succession issues that they’re working through.  But then more broadly, as competition gets fiercer in the space it’s really talent that sets apart one firm from another. 

 At the end of the day, PE is still a people-based business.  Firms, for example, are getting a lot more programmatic in how they approach their talent strategies.  They think about recruiting, retention, career management, their org design, things like policies, and certainly their culture.  So, at the end of the day, getting talent right is not only important at the fund level, but at the portfolio level as well.  It’s a major focus of the value creation teams. 

You know, the industry can make a lot of mistakes in hiring.  If you talk to the recruiting firms, there’s one that recently stated that 40 percent of their revenues came from correcting post-close mistakes in hiring.  And so, firms are trying to remedy that.  They’re trying to get a lot more analytical about who they hire and what’s the value proposition for those hires.  And clearly, and absolutely central to this conversation, they’re also very much focused on becoming a far more diverse place to work than they’ve been in the past.  Right now, women make up about 30 percent of the associate VP level employees and this percentage drops dramatically by the time they get to senior leadership roles.  Only 8% to 15% of senior leadership roles at PE firms are currently held by women.  So, a lot of work to do there.

Brown

Yes, unfortunately, these statistics I’m sure are not very surprising to our audience.  Private equity is facing, uh, many of the same challenges with respect to D&I that many organizations face.  Just thinking, um, can we take this a step further?  We have, on the one hand, a focus on attracting diverse talent, and at the same time we have the inevitable generational shift of wealth to millennials who bring a more socially conscious mindset.  As a result of this we’re starting to see this dramatic shift towards corporate responsibility and purpose, both in public and private spheres.  How has this movement manifested itself in private equity funds and across their portfolios?  What are you seeing?

Saenz

It’s a huge topic.  Over the last decade, PE has been on this journey.  It started with ESG and then it evolved into impact.  So, with a certain mindset towards actively seeking to do good with your investments, managing a double bottom line, over the last year there have been over US$5 billion in PE related impact investments according to the Global Impact Investor Network.  You see Bain Capital with its Double Impact Fund originally raising $400 million dollars, TPG with its Rise Fund originally raising $2 billion dollars.  Both of those firms are raising a second fund and other folks like KKR and Blackstone have followed suit. 

And, you see managers and investors starting to really hone in on this conversation.  Every day in the news now you’re seeing key leaders at all of the private equity houses really sharing that emphasis, sharing what they’re doing, and trying to set the tone from the top for their organizations at the fund level, at the portfolio level, etc.

Brown

So Andres, I mean, don’t get me wrong, I think that is fantastic, but the proof’s in the pudding.  Where is the money flowing right now?  What are the hot sectors?  What are the sectors that we’re expecting to see declines in the future?  Is PE really focused on making those kinds of changes and those kinds of investments?

Saenz

I think they are, and I think it’s evident in the way they’re migrating how they spend money across different sectors.  As an example, if you look at the oil and gas space it only accounts for about two percent of the deals that they did last year. Yet, if you double click in it, renewables remain a significant area of interest for many PE firms.  One of the longtime Nordic investors in the space recently announced that they are transitioning their portfolio to focus exclusively on renewable energy sources in the coming years.  It’s really about PE adapting to our future energy needs and sources.  And I think this thread of the impact that you’re creating and the value that you’re creating can be seen in many of the other different sectors.  Some of that impact comes from disruption.  And so, for the last several years it has been all about technology.  Technology accounted for over a quarter of the deals last year.  On the large end of the spectrum, you’re talking about taking large legacy software companies and repositioning them for a cloud-based world.  In the growth space, firms are looking at tech-enabled disruptors in mobility, fintech, and other areas that have both, again, financial value, but also social value.  

You take the consumer space, for example, you know, broadly speaking the sector has been facing some sluggish growth, you know, tighter margins, but that creates opportunity.  Many of the consumer companies are divesting things that would be “noncore brands,” and there’s emphasis in things like the supply chain, and data, and marketing companies.  So, you can find areas of tailwinds in each of these sectors if you know how to look for them.  All in all, I think consumer goods, services, and retail accounted for almost 30 percent of the deals last year.

Another area of both financial and social value would be healthcare, and PE remains very active in this space.  There are strong secular tailwinds such as regulatory change, aging populations, a shift towards value driven care, and a lot of health care IT enablers.  So, I think you do see the emphasis translating into behaviors and, ultimately, where the money gets spent both at the deal level and then in terms of value creation once it’s in the portfolio.

Brown

Yes, Andres, I agree, I think this is going to be a very interesting trend to follow, to see as PE gets more socially conscious over time and thinks about investing not only as having a financial return, but also an impact return.  What sectors are actually going to become those hot sectors of the future?

Saenz

Sure.

Brown

Just shifting gears slightly.  Funding has continued to be very strong through 2019.  Where are PE complexes getting their funding from?  Has the investor mix that’s attracted to PE changed over the last few years and where do you really expect it to go in the future? 

Saenz

It has.  You can certainly say it has been changing and evolving over the last several years.  PE funding continues to be, let’s say, dominated by pensions, foundations, endowments, but I think we’ve seen largely a new class of investors come in as well.  Sovereign wealth funds are investing more in PE.  You also have a lot more investment coming from high net worth individuals and family offices.  At Blackstone, for example, right now about $60 billion of the AUM is from these types of investors and over the next decade they want to quadruple that.  And that’s a trend that you see at the other large houses as well.  A lot of the top ten firms are reporting anywhere from ten to 25 percent of their new money coming in is coming in from that high end of retail.

Brown

So Andres, can you paint a vision of private equity in five years?  What do you think are the top three key trends that will shape the future of PE?

Saenz

Yes.  I think first I would start this notion of retailization of private equity investing, which, we touched on it briefly before, but the opportunity in the retail market is huge for PE.  Right now, in the US, the SEC is looking for ways of potentially modifying the accredited investor rules so that more ordinary investors can access these private market investments.  And PE firms remain very interested in the potential of the largely untapped 401K and defined contribution market.  It’s estimated at somewhere in the neighborhood of $6 trillion dollars.  So, this could be a real game changer.

Second, I think this notion of continued expansion in the other parts of the value chain.  We talked about credit, and growth capital, and other ancillary asset classes.  It has been one of the defining features of PE for the last decade, but we expect continued expansion here.  Right now, for example, growth capital assets are growing at roughly twice the rate of buy-out assets, and private credit has grown from $240 billion to roughly an $800 billion dollar asset class for these players.

And then thirdly, and I think it’s important to keep talking about it and keep emphasizing it because it’s going to be huge in the next five years as well, is this evolution in ESG and impact to more broadly creating value and being transparent around that value.  PE shops, impact oriented or not, create a wide range of economic externalities in their ordinary course of business.  And as the conversation continues to move globally to greater transparency, greater emphasis on creating positive social impacts, and articulating the value that you create above and beyond your financial returns, this is taking on a new level of significance for all of the firms.  And if you focus specifically on the PE lens, private equity firms can have a really good story to tell, they just haven’t necessarily been focused on telling it.

And so measuring the value that you create, financial and nonfinancial, and communicating how PE works and creates that value for multiple stakeholders becomes a critical aspect, I think, in the next five years.

Brown

I agree.  I think what you’ve described are some really powerful trends that are going to shape the way PE looks like in the future.  What are some of the characteristics and values that you think will define the leading private equity fund of the next generation to stay ahead of these trends?

Saenz

I think it boils down to four things.  We’ve talked about it, but I think it starts with purpose and transparency.  We’re not just talking about financial returns for shareholders, we’re talking about what value you are creating for all of your stakeholders.  And how do you measure this?  And how do you hold yourself accountable to it and be transparent about it?  Number two, data and technology.  It’s affecting every aspect.  Origination, diligence, value creation, exit, in the front office, in the middle office, in the back office.  You have to have a focus on it. 

Third, with so many funds out there, with so much money out there, you’re looking to have differentiated investment strategies.  And you can pick the dimension in which you have that.  Asset classes, sectors you invest in, the types of targets, the types of deals, how do you seek a certain angle, what playbooks you use, etc. 

And then last, and certainly not least, talent.  You can’t have an infinite number of differentiated strategies.  And that’s how you win in the private equity space and that’s how you create a win for the broader society at large.

Brown

So, you know, Andres, I think what you’ve described is a very complex and exciting future for PE.  It seems to me that it all starts with purpose.  Those funds that define and lead with their purpose are arguably going to attract the best talent, find the best ways to harness technology to create value, and that will, in turn attract the investment to allow them to best diversify their portfolio and set them up for future times to weather the economic cycles to come.  Very, very exciting times, indeed. 

Andres, thanks so much for joining the show today and for sharing your insights into the trends that are shaping the future of private equity.  We really appreciate your time.

Saenz

Thanks, Winna, my pleasure.

Brown

I hope you’ve enjoyed this episode of the NextWave Private Equity Podcast.  Please subscribe, review, and of course, share it with your colleagues and friends.  To find out more about the topics we’ve discussed check out EY.com\privateequity.  And I’ll see you on the next episode.

Brown

I hope you enjoyed this episode of the Next Wave Private Equity Podcast. Please subscribe, review, and, of course, share it with your colleagues and friends.

To find out more about the topics we discussed, check out EY.com/privateequity.  I’ll see you all on the next episode.

Disclaimer: The views of third parties set out in this publication are not necessarily the views of the global EY organization or its member firms. Moreover, they should be seen in the context of the time they were made.