OTPP's Karen Frank on What Lies Ahead in Private Equity
The full article, What does 2022 have in store for the private equity industry?, can be downloaded here.
The article appeared last month and included the following industry leaders:
- Joe Baratta, global head of private equity at Blackstone and a member of the firm’s board of directors
- Hugh MacArthur, partner at Bain & Company and head of the firm’s global private equity practice
- Brian Bernasek, managing director and co-head of US buyout and growth at Carlyle Group
- Rajeev Amara, founder of Arcline Investment Management
- Karen Frank, senior managing director and global head of equities at Ontario Teachers’ Pension Plan
OTPP posted this article on its website and I urge you to read it.
These are all industry titans but for the purpose of this comment, I want to hone in on what Karen Frank shared:
Buyouts: Will PE dealmaking in 2022 match the robustness of last year?
Karen Frank: Last year was a record year in terms of dealmaking, and private equity was a significant portion of that. I don’t see that ending as long as the markets hold out. Part of this is the pace of fundraising and the total amount of dry powder that’s available. People are keen to get that invested in opportunities.
I think that dry powder needs to go some place, and so far we have a deal environment that’s very conducive to that. This is also an opportune time for companies and private equity to join into partnership and think about how they navigate the waters going forward.
Some with a view to accelerating disruption in areas where they are strong, some with a view to shoring up balance sheets and making sure they’re well suited to weather the storms that may still come.
Buyouts: Will inflation or other economic factors impede dealmaking?
Karen Frank: If you think about it from the pension fund perspective, and you think about the low-to-negative rate environment and now the prospect of inflation, those are both big impetuses for us to stay invested – particularly in real assets and businesses with pricing power that keep pace with inflation. So, I don’t see it necessarily as an abatement to the deal environment. I think the market adapts.
Buyouts: Will asset pricing trends result in GPs working harder to generate returns?
Karen Frank: There’s no doubt that prices are increasing given competitive dynamics in the market. We always revert back to a foundation of value creation, saying we need to be in control and supportive of management and our partners about how we organically create value. This gives us confidence to weigh in and still deliver a risk-adjusted return in a high-priced environment.
One of the ways that we’re different from some funds out there is we’re long-term investors. Sometimes the value creation playbook is going to take longer to execute, sometimes you need to be nimble around that as market conditions change. We’re thinking about not the next 24 months and preparing a company for yet another sale, but about how we put it on a path to build long-term value.
Buyouts: What do you expect the interesting deal opportunities will be?
Karen Frank: We’re excited about tech enablement. Rather than looking exclusively at a piece of software or a digitized platform, we’re looking at companies and seeing where we can add those capabilities to take them on their journey and accelerate value creation. We think about technology not just as a standalone area of investment but as something that permeates all the sectors we find interesting.
Buyouts: Will the vigorous PE fundraising of last year continue into 2022?
Karen Frank: As we make commitments to funds, a couple of things are happening. One is the mega-funds – they come back with bigger and bigger equity tickets.
The reality for us is that to be able to continue to make those commitments we have to have an expectation of realization on the other side. We can’t continue to commit without having something come back.
Funds are also coming back faster and faster. They are segmenting their strategies, returning to the market with special [situations], credit, growth, regions, etc. We try to approach that with prudence, saying we have to manage aggregate exposure and build a diversified book on our end.
Many of us are about co-invest and driving the additional overall investment that comes with being a core or anchor LP. But as the funds themselves get bigger, you have to get bigger with them. So, the exposure to single managers is sometimes quite large. I think the exposure-versus-co-invest dynamic is one that will probably be an increasing trend in the market. It is one that we will balance quite proactively.
Buyouts: As private equity supersizes, should it be more transparent?
Karen Frank: I think all organizations have a duty of care to their stakeholders. And whether it is industry-based transparency, or regulation, or how those go hand-and-hand, I think additional transparency is a mutually beneficial way for us to work together. I hope that continues to be the direction of travel.
You’re always going to have a bit of friction between seats on the LPAC, between the LPAC and the fund, transparency of fees and expenses, etc. Historically, we’ve done well to choose our partners thoughtfully, and the way they interact with us is important. We’re on the right track but this idea of continuous improvement – being more transparent and involving us more – will hopefully be embraced.
As more funds become asset aggregators, through the proliferation of fund types and the fee-based model that they work to, in some cases that fundraising goes beyond institutions. It goes to private individuals, to family offices and down into the retail environment. As GPs start tapping on that type of stakeholder, transparency – really opening up about how they work and what their value proposition is – is key.
Buyouts: Will private equity make new inroads on the ESG front in 2022?
Karen Frank: For us, this has become a gatekeeping issue. E, S and G are all important to us. If we don’t have commitments or visibility on how either funds or portfolio companies are leaning in, it gives us real pause for thought. We have a lot of data points to realize that diverse organizations, ones that are aligned with ESG, deliver better and sustainable returns to their shareholders. Not every company, not every situation, will be on the same trajectory, but we expect positive movement toward each of these goals. That is one of things that helps to support our investment case.
Despite COP26 [the 2021 UN Climate Change Conference] and the urgencies raised there, I think we’re still early days in how the industry leans in on the environment – in terms of influencing portfolio companies, allocating investments and investing in solutions. We’re still some ways away from doing it effectively or fully understanding what good looks like.
Buyouts: Is private equity doing enough to ensure diversity in its own ranks?
Karen Frank: I joined an organization where I’ve been pleased at the commitment to diversity. Women, for example, are well represented on the board, the executive team, in asset group leadership and on the investment team. Private equity has been focused on getting bigger intake but has yet to see all forms of diversity, including at the leadership level. That will be something important for us to break through on a more industry-wide basis.
It’s a long road, but one where we’re starting to get critical mass. We know the inherent benefits of diversity. I’m also keen that we open up the aperture. We can’t just be talking about women, we need to be talking about all forms of diversity, equity and inclusion. The more progress we make, the more time and voice and mindshare we give to that, the more likely, I think, we’ll eventually get there.
Buyouts: Will the energy transition be a larger priority in 2022?
Karen Frank: We recently announced our commitment to net zero [in the portfolio by 2050, with 2025 and 2030 interim targets]. For us, it’s not about carbon-dumping. Some of the more recent investments we’ve made involved backing companies and management teams to help get to that transition. We’re in some cases taking on carbon, but only in circumstances where there is a transition plan to ensure we’re getting the business to a low-carbon environment.
In terms of the ability of private markets to put weight behind the technologies and capabilities that will help us crack this problem, I think there is a real opportunity. The industry is evolving very quickly. The way private equity will engage in climate and energy transition is probably going to accelerate because those opportunities are becoming more clear and more accessible.
This is an excellent interview where Karen Frank covers a lot of interesting topics.
Again, take the time to read the entire article here and read the insights from other industry leaders.
A couple of points I'd like to make on Karen Frank's perspective:
- Regarding inflation, there's no question that higher real rates benefit pensions because their liabilities shrink (higher discount rate means lower future liabilities). So, from an asset liability perspective, higher real rates are definitely good BUT if rates rise too fast and end up clobbering assets and the economy, and a deflationary scenario develops, then pensions are in big trouble again because real rates will head back to more negative territory.
- There's a lot of dry powder in private equity, pricing reflects this but you have to be invested. Pensions have added advantages like they have a long-term investment horizon and they have captive clients (so they don't worry about fundraising). This gives them time to realize on their value creation plan.
- Co-investments with big funds are critical, for OTPP and other large Canadian pensions. Funds are getting bigger and there are more opportunities to co-invest, lowering fee drag and maintaining a healthy allocation to PE.
- ESG and diversity & inclusion are critical for long-term success in private equity. I recently discussed how BCI and IMCO joined CPP Investments, PSP Investments and other other large LPs to take part in the data convergence convergence project which seeks to standardize environmental, social and governance metrics to provide a mechanism for comparative reporting in the private equity industry. This week, University Pension Plan Ontario (UPP) announced it was joining too. I think OTPP and others will soon join.
- I like tech enablement as part of the value creation plan and think there will be plenty of opportunities to invest in the energy transition economy, in private equity and other areas. Private equity will play a pivotal role as the world transitions to more sustainable energy.
Alright, let me wrap it up there, I am hoping to interview Karen Frank and Suyi Kim one day but for now, I'll take whatever I can find and share my thoughts.
Below, CNBC's Leslie Picker reports on investing in private equity is getting more expensive.
And CNBC's 'Squawk on the Street' team discuss private equity firm TPG, which made its public market debut on last month in the first big initial public offering of 2022.
Just remember what Mark Wiseman once told me when he was heading up CPP Investments: "If I could hire David Bonderman, I would but I can't afford to, so in private equity we will always invest with top funds and co-invest alongside them."