What are private investors thinking about?

Sitting here in the frozen, still somewhat locked-down tundra of another Canadian winter, it feels a little like everything has ground to a halt. Like the whole world is doing nothing but waiting on the next episode of “Billions” to drop. Like us Canadians are just sitting around wondering whether this Olympics may see a crop of non-NHLers win hockey gold again.

On the personal side, and my couch can attest to this, that rings pretty true.

As investors, however, not so much. And as for private market investors? Pretty much the opposite.

2021 was an absolutely torrid year in private equity in terms of activity, fundraising and performance. And so far, 2022 hasn’t let up. 

But against that backdrop and looking forward to the year ahead, what exactly are investors talking about?

We believe it’s fair to say that this year – as investors – we need to add just a bit of anxiety to the emotional mix as well. Lots of talk of new and growing headwinds around inflation, interest rates, volatility, oh my!

And while those remain top of mind going forward, there were three undeniable winners as the most discussed topics within investor portfolios. Something no one calls the “3 P’s” – until now: Pacing, pricing and performance.

Pacing. The accelerated pace of fundraising and deal making in the private markets. At Hamilton Lane, our primary fund deal flow was up over 20% from 2020 to 2021. Best estimates of 2021 fundraising reflect the increased deal flow as we see a new record likely being set in 2021 at ~$1.2 trillion. In short, more funds than ever are back in market fundraising, and they’re raising larger and larger funds against outstanding performance and strong deal flow. This is keeping investors very, very busy.

Pricing.  Let’s cut to the chase here: Prices are high in the private markets. Is this concerning?  Sort of.  This is certainly something to keep an eye on, especially if one considers it a sign of a ‘market top.’ 

Now for some perspective: Prices are expensive everywhere – public markets, gas stations, grocery stores. In the private markets this is a trend that began about a decade ago and has continued.  Today, the private markets multiples are at or above all-time highs.  And while they remain below public market multiples and have relatively high equity cushions, the pricing in private markets is major. 

Pricing, however, is just one factor in the dynamic of private markets investing.  Remember, the basic premise of the private markets is 1) buy, 2) enhance/grow/improve/fix, and 3) ultimately sell private companies. The private markets operate in that sweet spot between buy and sell, by using time and the general partner’s ability and expertise to create upside value.  Clearly, while the price at which a company is purchased plays a significant role in the investing equation, it is not the sole determinant of the outcome. 

Lastly, let’s not forget the active, control-oriented investment strategy of private investing versus a more passive public market context. That is generally why investors in the private sphere can better "control their own destiny" with ultimate investment outcomes. In fact, our data shows that the vast majority of investment returns are not driven by the buy low-sell high mantra – they’re driven by good old-fashioned earnings growth.

Performance. With that as a backdrop, let’s acknowledge that while investors ask about pricing, their primary focus is, and should be, around performance.  After all, performance is the overwhelming reason investors allocate to the private markets.  And the private markets have delivered (and then some).

Consider the following: If you invested a dollar in in the public markets in 2017, you’d have $1.53. Not bad. But if that same dollar was invested in the private markets, it would be worth $2.22.

Impressive. In the private markets, we’re long-term investors, so we tend to focus on outcomes over longer time periods.  So, what if we were to zoom that example out over the last two decades? Same result. In the last 20 years, the pooled average (note the emphasis) private equity buyout and private debt funds have outperformed their public market alternatives in each and every vintage.  And, they’ve done so by significant margins – to the tune of over 1,000 basis points for equity; and over 600 basis points for credit.  Undeniable.  And those margins increase if you manage to invest better than average.

• It’s important to contextualize (fancy word for benchmark) this performance.  Here are the stats on buyout returns from our data scientists: The median performance for the 2016 through 2020 vintages are competing with the top quartile returns seen earlier in the decade.  Said differently, today’s median performance is higher than the best 10 years ago.  And 10 years ago was a good time to invest.
• If you were to rank the top-quartile threshold for each vintage year in Hamilton Lane’s data set from 1982 to 2020, the most recent five years would be ranked 1, 2, 3, 4 and then 8 for 2020 through 2016 respectively.  What’s the moral of this tale? Even deals done in that high-priced environment have resulted in the best performance in the industry.

Here, we have to acknowledge one of the key challenges the above benchmarking data creates for private market investors. In a period where median performance for the asset class has been so good – and has been coupled with a healthy dose of distribution activity, to boot – how do investors make selections regarding which funds and mangers to support as they come back to market?  That is a much larger topic to be discussed another day.

And finally, a reminder that it’s all relative… Not only the ability to dictate outcomes from active management, but purely on a "statistical” basis, current performance of the public markets is close to its historical high (albeit that has come off as of late).  While private market returns are also elevated above historical median levels, they are not nearly to the extent of what we have seen in the public realm.

And so, if you are a believer in a ‘reversion to the mean,’ it is hard to argue that the public markets won’t have more downside exposure going forward.

So there you have it – some data and analysis on the “3 P’s” of the private markets. And while Canada may be under a deep freeze as 2022 gets underway, the private markets are hot – with no end in sight.

Mike Woollatt is the Head of Canada for Hamilton Lane, an independent provider of global private markets investment solutions.

_{Source: Hamilton Lane Data (January 2022)}

_DISCLOSURES

_{As of January 25, 2022 unless otherwise noted.}

_{The information contained in this presentation may include forward-looking statements regarding returns, performance, opinions, the fund presented or its portfolio companies, or other events contained herein. Forward-looking statements include a number of risks, uncertainties and other factors beyond our control, or the control of the fund or the portfolio companies, which may result in material differences in actual results, performance or other expectations. The opinions, estimates and analyses reflect our current judgment, which may change in the future.}