Ferneini: Absolutely. There’s still uncertainty despite being a year and a half out and almost half of the population having gotten vaccinated here in the UK. Will people go back to the office 100 percent like before? Will it be more like 30 percent, 40 percent? Investing in COVID-hit businesses will require some degree of “leap of faith”; if you are happy taking such risk, you would prefer to be conservative on the growth assumption going forward. But again, that might be perceived as an opportunity for some investors.
Jacobson: Building on that, what the pandemic is certainly making us do is rethink a lot of what we’ve known in the past. There are certain sectors that we believe are generally economically resilient. These companies do well in bad economies. However, they were not built for lockdown—gyms and pubs, for example. Unlike dentistry and veterinary care that I referred to earlier: we know how those are going to recover. But if you take a pub or a gym, we’re not sure what their new business model is exactly going to look like. For example, how many people will be allowed in a gym at the same time and what will social distancing look like there?
Ferneini: I agree with that, and on the other side, software is a rapidly growing sector that has seen tailwinds from the COVID-19 pandemic as software allowed businesses to keep running despite the lockdowns. Today, the software sector counts for around 20 percent of total private equity commitments—it was more like 2 percent in 2005 or 2008. The growth of the revenue and the profitability of the sector has been interesting to us.
Jacobson: Interest rates are also going to have a major impact on all of this. We’re seeing spikes in some inflationary indicators and never thought this conversation would happen so quickly. It’s unclear whether that will persist, but there is now a view that rates might begin to tick up. The cost of capital in the private equity industry is significantly dependent on the state of interest rates, and we’ve had basically zero percent interest rates, or close to zero, since the financial crisis more than ten years ago. If rates start to spike up, perhaps in reaction to inflationary pressures, it could have a meaningful impact on the private equity industry. There are some potential clouds out there. If we get back to 2 or 3 percent, that’s a meaningful change, and I do think that would jolt the equity markets and depress valuations.
Ferneini: I agree. From a macro perspective, what has been driving increased fundraising in private equity is the very low rates and the pursuit of yield. I am carefully watching the Fed and ECB’s monetary decisions alongside inflation indicators as macro-risk is there and could have a negative effect on markets and valuations.
That’s a good segue to talking about SPACs [special purpose acquisition companies] as a novel exit path, which kind of is good for us as private equity investors because SPACs are a direct result of the liquidity in the system. We like it because it’s repeatable. We’re seeing exits of underlying portfolio companies through SPACs, which is one of the drivers of increased liquidity and distribution to private equity LPs [limited partners]. It’s not a new idea, but SPACs have been booming over the past year as a result of the current expansionary monetary policy and ample liquidity in the markets.
Jacobson: I don’t think anyone would have predicted those trends happening so quickly. The question on SPACs will ultimately be: Where does the counterbalance end up? Will they wind up in some ways being competition for private equity and acquiring assets?
Something else that merits more discussion is how the pandemic highlighted a lot of deficiencies in our economies and our societies, and it highlighted inequalities. That’s led to an increased focus on ESG [environmental, social, and governance] considerations, and on diversity and inclusion initiatives. This is something that had already been percolating for some time in our industries, but we’ve seen a massive acceleration. This is good business and the right thing to do. It took a pandemic to really shine a light on all of it.
Ferneini: The LP community is much more aware about ESG and is asking for more ESG compliance. The GPs are recognizing that “values drive value” from an investment perspective. Before ESG was often treated like a “check-the-box” exercise. Now we are seeing general partners improving their ESG frameworks at both the fund and portfolio company level. We welcome this change, which would hopefully have an impact on building a better, safer, and more diverse society.