Speaker 0:
Christian Dobson is portfolio manager for alternatives at border to Coast. He joins me now, Christian. We're hearing an awful lot about the private equity market at the moment. What's the current environment for private equity?

Speaker 1:
Yeah. So if I start with fundraising, fundraising markets for private equity firms is more challenging at the moment.

Speaker 1:
Um, this has largely been driven by a couple of factors. One of those is a decline in demand from limited partners. So limited partners. What I'm referring to, there they are the investors in private equity funds. Typically, private equity funds are set up as GP LP structures, general partner being the private equity firm and limited partners being the underlying investors. So we're seeing a a slight demand slight pullback in demand from LP s or investors in terms of private equity funds.

Speaker 1:
That is driven by somewhat the denominator effect, but also other structural reasons that are at play in the market for specific investors. Um, that is making fundraising more challenging for firms. In addition, we're also seeing a sheer number of firms in the market, and the volume of firms in the market is making it challenging for funds to fundraise. Often, funds are coming back to the market seeking to raise increased amounts of capital, and there just isn't that amount of capital at the moment to go around.

Speaker 1:
In addition, if I talk about deal activity, so deal activity has slowed materially since about the mid point in mid point last year through to now, UM that is driven by a couple of factors, the first being a reduction in availability of financing. So at the larger end of the buyout market, banks have been a big player in that market. Um, and they have pulled back materially from the amount that they're willing to do. That is a result of some of the

Speaker 1:
deals that maybe didn't perform too well for them last year. So where they lent money to a deal, they will typically look to syndicate that out into markets. However, given the rising rate environment last year and the rapidness of some of those rate increases,

Speaker 1:
there were deals that they agreed to do but were unable to syndicate before interest rate rises took form and they were left holding those positions at a loss. And so they've pulled back from the market. We have seen private credit managers step into that space through direct lending to offer that support to buy up markets. That is much more at the mid market end of the scale, and so some of the larger buyouts are are really struggling to find financing at the moment. So

Speaker 0:
what's all of this doing to valuations?

Speaker 1:
Yes, so so valuations in private markets are a little bit different to those in public markets. So

Speaker 1:
where public markets declined over the last 12 to 18 months, we saw some falls in public markets. Um, private markets have started to reflect those. We saw a decline in private market valuations around the Q two period last year.

Speaker 1:
Um, in terms of what we saw, valuations then roughly remain flat through Q three and then Q four. Um, I guess a couple of points to note are, firstly, that private market valuations tend to be more gradual in both their uplifts and their down lifts versus public markets. Um, so they won't typically fall by as much as public markets and won't fall at the same speed as public markets, but equally when public markets bounce back. They also won't take the full impact of that on the upside as well. Um,

Speaker 1:
the other point to note as well is that we don't necessarily from a headline valuation perspective, you don't see what's going on with the underlying portfolio companies. So from our experience, a lot of underlying portfolio companies have continued to perform strongly. Be that through growth in their e BT a, which has somewhat offset some of those valuation multiple declines that we've seen.

Speaker 1:
And so maybe that is what has driven. I guess the valuations maybe not to fall as much as we've seen in public

Speaker 0:
markets. And so what are some of the other challenges that this, given that backdrop, that this throws up for investors such as

Speaker 1:
yourself? Yeah, well, I guess the first, the first one to consider, maybe, is around value creation. So how are private equity firms able to drive value in the investments that they make over the last sort of 5 to 10 years? Funds have benefited from a sort of a multiple expansion environment where

Speaker 1:
the valuation multiple they sell a business for is larger than the valuation multiple that they bought the business for entry solely as a result, of sort of the rising, um, sort of valuation environment. We're not seeing that now, and firms are likely unable to benefit from that over the next few years. And so really, it's about driving that underlying portfolio company led growth in terms of operations in terms of maybe add on acquisitions to drive that growth and then realise that strong returns one of the strategies we are seeing a bit more of is buy and build.

Speaker 1:
So that's where a firm buys an install platform. And then over the next over the next few years, they complete a number of add-ons and M and A transactions

Speaker 1:
to grow that platform in organically and can often do so by buying those smaller add-ons at lower valuation multiples. And they bought the initial platform. For that was to draw helps to drive down your average entry multiple, and therefore you can see a bit of an update on exit as well as a way of driving value. So pulling some

Speaker 0:
of these themes and threads together, what what do you think are the main potential opportunities in private equity over the next 12 to 18 months?

Speaker 1:
Yeah, I think I think some of the things we're seeing. I think we're seeing

Speaker 1:
a growth or a growing concentration of capital with some of the larger, more well established managers, as as LP s look to rationalise their portfolio, so to speak. So in the public markets, in times of volatility, you see a sort of flight to quality. And this is essentially the private markets and private equity equivalent where LP s are putting more money with their longer term relationships. They're more well established firms. They've got longer track records and maybe larger teams and larger capabilities in terms of resource. Um,

Speaker 1:
another factor at play that's driving that as well, I guess, is the increase in reporting requirements that some LP s are facing. And some investors are facing around whether it be e s g, more regulatory reporting. And so it helps for firms with larger teams that have resources dedicated to that area to help meet those needs. That's not to say the environment is is not there for the smaller emerging managers. I mean, in our in our portfolio, we focus on a mix of developed or a mix of established managers as well as those more new emerging managers where there are potentially more paths to value creation.

Speaker 1:
Um, it is just being a sort of a sign in the market that we're seeing at the moment.

Speaker 1:
Additionally, we're seeing growth in continued growth, even in sector specialism even by both historically been generalist managers as well as those firms that that dedicated to one individual sector. So this is where firms are taking sort of 2 to 3 sectors, really sort of doubling down in those areas, having separate teams focused on those sectors, building that knowledge and expertise that can aid with sourcing but also with value creation.

Speaker 1:
Really, it's about driving, finding that competitive edge in the market in a market that is becoming increasingly competitive. How can firms differentiate themselves and sometimes that is through having real deep sector knowledge and experience where you can come into a deal and and pitch to an entrepreneur is more like a semi strategic than a financial investor and so help to drive that value creation through the journey as you take ownership through to exit and finally one of the other one of the other areas we're seeing renewed growth in is around climate impact and climate investing.

Speaker 1:
Um, so border to coast, we we manage one of the largest pools of climate dedicated private markets money in the UK. And so this is a universe that we've seen expand over the past couple of years and expend expect to continue to expand over the forthcoming years. Um and really, this is firms that have either moved into the climate space with dedicated climate strategies.

Speaker 1:
Managers that have historically had a focus on climate but are now growing their strategies, Really? And these firms are trying to take advantage of all the investment opportunity that there is at the moment around the pathway to net zero

Speaker 1:
and the opportunities that come with that,

Speaker 1:
even beyond investment. We're seeing firms that haven't necessarily got a climate focus improve the levels of their E S G and climate reporting at the portfolio company level to really focus their companies on this, both due to LP demands around reporting requirements, but equally as an avenue for value creation, as well as those companies that are set up to set up to succeed in the longer term environment, be that in a maybe particularly different climate situation,

Speaker 1:
are likely to be better financial returners as well as impact returners as well.

Speaker 0:
We have to leave it there. Christian Dobson. Thank you. Thank

Speaker 1:
you.