ACG New York recently announced the results of its Annual Middle Market Survey, which found that 73% of respondents believe PE investments will outperform the S&P 500 in 2015. Results were fairly mixed when respondents were asked about the ability of PE to raise additional capital this year compared to 2014. We recently spoke with ACG New York Board Member Randy Schwimmer, founder of The Lead Left and former managing director at The Carlyle Group, to get his thoughts on the survey and the PE landscape in 2015.
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If you are in agreement with the survey results, what do you believe will be the driving factor(s) that will propel PE investments to outperform the S&P 500 in 2015?
I do agree with the survey results. In periods of rising interest rates, public equities tend to do worse than in periods of falling rates. Also, private equity returns, while generally down over the past five years, have been much more stable than public markets, which have displayed increasing volatility.
While the survey produced mixed results in regard to the ability of PE shops to raise additional capital in 2015, how do you see the capital raising effort for PE firms playing out throughout the year?
There continues to be plenty of LP cash seeking better returns in this near-zero interest rate environment. But there are also higher expectations from those investors. They are demanding more proprietary origination, more distinguishing investment practices and more opportunities to co-invest with GPs. In addition, there will be increasing emphasis on investing with only the top-tier performers. Middling track records will have a very difficult time raising money.
If the Fed does indeed raise rates at some point this year, as the survey predicts, what effect do you think that will ultimately have on PE?
I don’t think rates in themselves dictate PE behavior. What drives investing is how macro changes (like energy prices) affect industries to produce value. For some GPs that invest in financial services, there may be an eye on systemic issues, like whether mutual funds will benefit in a higher-rate climate. But in general, the predominating view is that rising rates point to improved economic signs—like improved earnings—which overall is a benefit to PE portfolio companies and makes achieving projections a bit easier.
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Do you see any particular sectors PE will target that will propel PE investments to outperform the S&P 500 in 2015?
Interestingly, energy may prove to be one of the best sectors this year. Depressed oil prices, and lower valuations along with them, make buying opportunities easier. Apollo, to name one firm, has publicly announced its intention of taking advantage of this dislocation. Healthcare is another sector that has experienced much volatility of late, mostly due to concerns about Obamacare. Finally, technology continues to be the engine that drives many growth businesses today. This could be the biggest opportunity for GPs that own (or understand) specific proprietary applications with high barriers to entry.
What are your thoughts on the capital raising efforts in regards to oil and energy funds that may be created due to the recent and ongoing volatility in the space?
As noted above, firms with experience and existing investments in the space will be able to raise capital to take advantage of dislocation in the sector. I would also think this window of opportunity has already begun to close as oil prices stabilize and analysts call for a return to more normal levels.
The last time we spoke, you stated that there was no lack of capital in the debt markets available to finance private companies. Do you think that will still apply throughout 2015? Do you see any potential headwinds threatening PE’s access to capital in 2015?
Even in the first (eight) weeks of this year, there have been at least a dozen announcements of new firms starting direct lending platforms. I expect to see that trend continue for the balance of 2015. In terms of headwinds, the biggest issue continues to be bank regulation restricting involvement in leveraged lending. But the amount of non-bank capital flowing into the space will more than make up for that headwind.