Welcome to the latest issue of Private Equity Strategies. In this issue, we take a look at how Brazil is bouncing back after recent turmoil in LatAm’s largest economy.
Our data heavy year-end issue also looks at the expectations gap between investors and GPs both from a transparency standpoint and from a technology standpoint. Independent analyst Roger Beutler also takes a look at the fundraising environment as we head into a new year.
Data from Coller’s Private Equity Barometer shows that investors are warming to European private equity as they look for new, global opportunities. This trend is backed up by an examination of recent changes in France by lawyers for Latham and Watkins - recent legal trends show positive regulatory changes for private equity in France.
Finally, in our Movers & Shakers section, we highlight new transactions and funds from Silverpeak, NEXT Investors, DSC Quantitative & Northleaf.
We hope you enjoy the issue - stay tuned for new releases in 2017 and please reach out if you would like to contribute.
Bailey Mccann, Editor
mccann[at]opalesque[dot]com
Brazil Bounces Back
By: Oscar Decotelli, DXA Investments
Negative news and information have dominated the headlines regarding Brazil for the past several years. The media have focused on various cases of public corruption which are at least partly responsible for the major recession now affecting the overall economy. However, the fundamentals of the Brazilian economy remain sound, and significant opportunities exist for the long term investor to take advantage of uncommonly low entry points.
A bit of history
Traditionally, investment in Brazil has been a tricky proposition; one fraught with uncertainty. Since the latter part of the twentieth century, public and private leaders have worked to achieve economic and political stability, and thus enhance the international reputation of this sizeable and significant country.
In 2002, Brazil elected its first leftleaning/ socialist President, when Luis Inácio Lula da Silva was inaugurated on 1 January 2003. This event was followed by a period of momentous economic development from 2003 through 2014-the longest period of positive growth and capital appreciation in Brazilian history. With the resulting reputation of Brazil as an economic and investment darling, knowledgeable leaders and professionals recognized the need for additional significant structural improvements -- efforts which continue to this day. Paramount among these needed enhancements are restructuring the social security system, simplification of the tax laws, and labor and political reform.
In 2014, the eyes of the world focused on Brazil as it hosted the World Cup in soccer. Meanwhile, the political and economic base was shaken to its core by a series of landmark events. Brazil entered a new phase as its socio-economic strata realigned and people no longer accepted the “business as usual” mentality.
Citizens demanded a “clean” and professional leadership class. This sentiment was embodied in “Operation Carwash,” which began as a minor prosecution of car wash businesses which were used to launder money, and metastasized into the largest corruption investigation and scandal in Brazilian history. To date, an elected President (Dilma Rousseff) has been impeached, more than 2,000 individuals implicated, authorities have arrested and jailed over 200 individuals from every level of society, including billionaires, politicians and other leaders; the last chapter has not been written as prosecutions continue.
Between 2015 and 2016 Brazil endured the worst recession in recorded history while the economy contracted by 7 percent in each of those years. However, the bedrock remained solid throughout, and now fundamental measures of economic health have begun to evolve dramatically.
From its peak of 10 percent in 2015, inflation has retreated to an annual rate of approximately 3 percent in 2017. Similarly, interest rates which spiked at 14 percent in 2015 are now at 7.5 percent and trending lower. Brazil has begun the arduous but requisite process of structural transformation. The next decade will present innumerable opportunities for advantageous private investment in businesses with sound management and fundamental financial strength.
Where we go from here
Brazilian businesses provide some of the best risk-return ratios in the world. Enticingly high return multiples on equity and double-digit interest on debt instruments are a reality in the arena of Brazilian investment today. Opportunities should be viewed through the prism of small and medium investment opportunities where local knowledge and expertise is requisite.
The Brazilian middle class has many of the same aspirations as those in developed markets and many of the same consumer habits. By focusing on local companies that are well positioned to take advantage of those consumer interests, investors can expect to see multiple expansion and a long runway for future growth.
Expectations Gap Persists Between LPs and GPs, Survey Shows
By: Bailey McCann, Private Equity Strategies
New survey results from SEI & Preqin show a persistent disconnect between investment managers and investors. Preqin puts the total alternatives market at approximately $7.7 trillion across strategies and investors in the survey indicate that they have plans to continue to allocate to alternatives. However, investors also expect more transparency, as well as a vast operational and technological infrastructure - all with lower fees.
“The disconnect between what LPs expect and what it means for the GP continues to be significant,” says Jim Cass, Senior Vice President and Managing Director, at SEI Investment Manager Services in an interview with Private Equity Strategies. “For firms that aren’t running mega-funds, there is a significant cost to do business and that puts pressure on GPs and what they can do.”
According to Cass, as investors have moved into alternatives they have also set the bar higher for the managers they select - in some cases trading away outperformance for the consistency of mega-funds. As a result, mid and small-tier GPs have moved to offer more fund structures and separately managed accounts that let LPs pick and choose best ideas. While that works for bringing in new business, it also sets up an increasingly complex account management structure for GPs and can make it difficult for LPs to compare peer managers across vehicles. The multi-structure approach also removes resources from investing in order to meet growing reporting demands. In the GP survey, managers listed investor reporting/service as the top area where IT resources were allocated in 2017, portfolio management came in fifth. Based on resource allocation, there is arguably more innovation in account structure than there is in finding investment ideas.
Past performance determines future relationships
While past performance may not determine future results, it does determine future relationships. Data in both surveys shows that LPs are allocating more to alternative strategies but they have moved out of hedge funds as a result of recent lackluster performance. 72 percent of respondents said they expected to see the most asset flows going to private debt, compared to hedge funds, where only 26 percent saw growing demand. Infrastructure, private equity, and real estate demand are also outpacing hedge funds.
According to the surveys, investors are looking to private debt as a result of high valuations in the public markets. Private debt is viewed as a diversifier asset class that is broadly uncorrelated to the equities market.
The move away from hedge funds has slowed somewhat this year, as performance has rebounded. Hedge funds have posted seven consecutive months of positive returns according to Preqin data and asset flows are broadly positive across strategies. However, it’s too early to tell if this is a trend that will last.
SEI’s Cass notes that investors have started to look for equities strategies that have downside risk protection as a component which is bringing them back to hedge funds. “It’s hard to make the case for hedge funds when the market is only going one direction,” Cass says. “But investors have started looking at ways to get out in front of a correction - they want exposures that could weather a downturn.”
Article by Opalesque
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