It’s no secret that the impact of inflation on the economy has spilled over into the alternative investment industry, despite optimistic investor prospects for 2022. EisnerAmper’s 7th Annual Alternative Investment Summit, titled Raising the Curtain: The Next Act for Alternative Investments addressed this timely topic during a virtual panel discussion called “Inflation’s Impact on the Global Market Ecosystem.” Speakers explored the impact of inflation on the economy; the outlook and deal portfolio for alternative investment managers; and the challenges, risks and opportunities in this market cycle.
- Lisa Shalett, chief investment officer and head of the Office of Global Investments, Morgan Stanley Wealth Management;
- Christopher W. Kersey, Founding Managing Partner, Havencrest Capital Management; Y
- Gautham Deshpande, partner, EisnerAmper (moderator)
Some topics were discussed here:
Impact of Inflation on Hedge Fund Managers:
The panel discussed three ways inflation will affect hedge funds in the short term.
- Higher inflation leads to higher nominal interest rates, which lowers risk-related asset multiples and creates a need to recalibrate the valuation framework.
- Fund managers should differentiate between volume-driven operating leverage and pricing power when choosing stocks, as pricing power can be volatile during periods of inflation and operating leverage is the true growth related with the volume.
- Finally, portfolio managers should review the role of real assets in a portfolio that inherently has built-in inflation protection, including those tied to infrastructure, real estate, and capital-intensive areas of the economy.
Impact of Inflation on Private Equity Fund Managers
Inflation also affects private equity fund managers in the following ways:
- Exit activities will slow down and it is essential that fund managers are patient and wait for favorable exit opportunities.
- An increase in interest rates will lower the valuations of portfolio companies.
- Holding periods will be lengthened, so both General Partners (GPs) and Limited Partners (LPs) will need to be patient to get the most value from an investment.
Next steps for private equity fund managers
In the current environment, managers are being encouraged to focus on a few key things, including “real operating value added and not just financial reengineering value added,” thematic investment, and for public companies to focus as much on their core business like in high school. The non-core trading approach will lead to other investment opportunities, including taking private opportunities or PIPE opportunities. Finally, GPs should change their investment criteria to invest in companies that have greater pricing power, greater margin protection, limited exposure to government reimbursement, and limited exposure to geopolitical risk, as well as those that are unaffected. for discretionary spending or risk of government shutdowns.
How do private equity managers adjust their portfolios?
Private equity managers are adjusting their portfolios to ensure they deliver risk-adjusted returns to investors in the following ways:
- Strengthen your balance sheet and use cash strategically;
- Review inorganic growth strategies as organic growth strategies are slowing down;
- Infuse technology into service platforms as the revenue model is optimized and will potentially increase the starting price; Y
- Buy investments at the right time without paying too high a price.
How is inflation affecting portfolio companies?
Wage inflation is reducing the margins of service companies. To combat salary inflation, successful companies highlight their mission and culture to attract and retain employees. Commodity inflation is hitting product companies. To combat this, companies are redesigning their product lines and implementing strategies to pass costs on to their customers.
Which parts of the market offer relative value or opportunities?
Opportunities exist to find defensive growth investments with fair value at reasonable prices. One sector where opportunities are available is the health sector. Value or cycle oriented opportunities will outperform and companies that embrace operational excellence, technology and automation will tend to outperform and create upside opportunities. Other industries that present return opportunities are the financial services, energy and consumer services industries.
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