Why private equity is prepared to weather the coming storm
As growing macro and geopolitical tensions including rampant inflation, the war in Ukraine, and the ongoing pandemic continue to linger, we are entering into arguably the most volatile economic period since the 2008 financial crisis. At Moonfare, we regularly speak with some of the brightest investors in the world, and the overarching theme from these conversations is the same: this feels like a perfect storm. However, while there may be rocky times ahead, I am confident that Private Equity is better positioned than ever to weather this economic downturn, while also offering individual investors a valuable alternative asset class to insulate their portfolios from what’s to come.
The current market backdrop and what it means for future returns
Without a doubt, inflation is one of the greatest challenges facing our future economic prospects. We have not seen inflation rates this high in decades, and they aren’t going away anytime soon. Our ability to counter inflation in the near term will largely depend on companies’ abilities to pass on cost pressure to their final consumers, which will likely create an additional wave of inflation down the road. One of the biggest factors driving this spike is the geopolitical environment and its impact on the global value chains including energy, healthcare, and semiconductors to name a few. We are seeing broken value chains in all of these sectors across the globe, and it could take 3-5 years before we reach some sort of normalization.
And here is where the beauty of private equity comes into play. The asset class provides a natural hedge against inflation, and in our view private equity has to be a key component of every portfolio moving forward.
While inflation is a pressing issue that could take years to address, what concerns me most is the risk of global unrest. The potential for food shortages as a result of the ongoing conflict between Ukraine and Russia and the droughts plaguing Europe are particularly alarming. Beyond the war in Eastern Europe, the United State's relationship with China continues to fray, increasing the probability of some form of further escalation in the foreseeable future.
With these factors coalescing in a similar timeframe, we are very likely entering into tough times for the short to mid-term. We have seen high volatility in the public markets over the past few months, and valuations in key sectors like tech have been compressed by as much as 60%. While the public markets are subject to swings like the ones we have seen recently, the private markets have the necessary resources and experience not only to withstand but also to take advantage of these choppy waters.
Why private equity is resilient
Although private markets are not entirely decoupled from public markets, they have historically proven to be far more resilient due to the benefits of what the industry calls the active ownership approach. Under Private equity’s governance model, the owner sits at the same table with management, allowing for quick decision making and alignment of interest. In addition, the major players in the industry have access to tremendous operational resources that allow them to quickly analyze, adapt, and pivot to the new reality. This active, long-term-oriented approach is needed most in turbulent times and often helps private equity owned companies emerge from a recessionary environment even stronger.
The current valuation reset offers opportunities. Private equity funds are currently sitting on record levels of dry powder with the ability to deploy capital fast and very flexibly. The major players learned valuable lessons from the 2008 financial crisis and now maintain their own pools of capital for all sorts of transactions including credit and infrastructure. The past 10-12 years effectively served as a honeymoon period in private equity, with very few funds delivering less than 2x returns. This trend didn’t separate the great players from the average players. What is needed now are managers with many years of experience, who have already been through downturn cycles and have the expertise and resources at hand to create organic value, not only in booming but also recessionary periods. The coming cycle will allow the skill-set and resources of these managers to shine, which is why Moonfare instituted such a rigorous vetting process for funds we bring to the platform.
Moving forward
While private equity funds had the luxury of studying their mistakes from 2008 to mitigate the effects of future crises, the public markets have remained largely unchanged, placing individual investors at far more risk of capital loss. However, unlike during the 2008 financial crisis, individuals now have access to private markets and can help insulate their portfolios from an impending downturn. Platforms like Moonfare are seeking to democratize access to private equity, allowing retail investors to invest directly into some of the best performing PE and Venture funds globally at low minimums.
As a result, private investors can now take advantage of the resources and governance procedures the private equity industry has developed to generate its historically high returns. While we have made significant progress in democratization, I am confident there is more to come in order to truly open up the asset class to a broad range of private investors, and we at Moonfare look forward to being a part of this global movement.
---
Under the spotlight: Steffen Pauls
Steffen founded Moonfare in 2016 with the vision to democratize private investing. He runs the company as Chairman and CEO. Steffen is a serial entrepreneur with a strong background in the private equity industry. Before becoming an entrepreneur Steffen served as a Managing Director of private equity at KKR. While at KKR, he was responsible for the firm’s coverage of the German market.
Prior to joining KKR, Steffen was co-founder and served as Chief Executive Officer of firstfive AG. He served as Chairman of The Supervisory Board at A.T.U Auto-Teile-Unger Investment GmbH & Co. KG and as a member of the Advisory Board at Versatel, Serbia Broadband and Hertha BSC. Steffen holds a B.A. with high distinction from the University of Mannheim and the Ecole Superieure des Sciences Economiques and a Ph.D. from the University of Trier. He worked as a research assistant at Harvard University where he wrote his master thesis.
For more expert insights from Steffen Pauls and other industry leaders, be sure to join us at SuperReturn North America >>