Being a visionary is an advantage in private equity

Private equity returns were record-high globally last year. Elo’s private equity investments also made an excellent return of 42 percent in 2021. Karita Meling, Elo’s Head of Private Equity, can you give us a bit of background for the high returns?

Long-term investing in the market

Elo’s private equity returns are the result of investments made over the course of several years. Investments made since the year 2014 have matured to exit and the returns were boosted by the portfolio companies’ positive earnings. Well-positioned companies in this exceptional market focus typically on digitalization and services. Company exits were accelerated by the globally recovering economies and the strong stock market.

Strong earnings support valuations

Private equity returns reflect company valuations in addition to capital gains. Portfolio company performance has been strong compared to the year 2020 which has led to higher valuations. The value of a company is measured by the ratio of debt and equity to earnings figures which is then compared to peer company ratios on the stock market with considerable discount. The final company value is only known at the time of sale.

Visionary and experienced managers wanted

A fund comprises of a multitude of portfolio companies, and it takes a long time, usually over 10 years, to be able to see the outcome of a fund. A term of a fund contains better and worse financial periods. Being a visionary works to one’s benefit as one must have a view of how the world stands 5 to 10 years into the future. Good fund managers have a long investment experience, either directly or indirectly through their funds and have a track record of high returns. These are the type of managers that are most sought after by investors.

Fund managers made use of what they had learned during the financial crisis and applied it to the Covid-19 pandemic and because of that experience, rapid actions were taken. Companies closely monitored their available capital and costs protecting core. The pandemic hit industries in very different ways. Companies that had investors capital on their back had an edge to many others. It opened possibilities for companies to invest or consolidate which consequently led to an improved market position.

House of professionals

Elo has its own private equity team of portfolio managers, analysts, and legal counsels. We manage the entire investment process ourselves, from fund selection and monitoring to coverage. We have spent hours upon hours into building a global network and we have strong visibility into the fundraising timetables. Globally speaking, we are a small private equity investor, but with unrelenting work we have managed to become investors in some of the best funds in the world. Communication with fund managers during the pandemic has been done virtually and travelling has been replaced by a broader attendance in annual meetings and update calls which has been beneficial for an investor like us.

You have followed private equity through the eyes of a pension insurance investor for a while, what has changed in recent years?

Private equity is on the rise…

Interest in private equity has increased due to attractive returns and provides less volatility to movements in the market. Private equities have grown to become a significant part of investments and new sub-categories have appeared.
Private debt investments make up a big portion of the private equity investments and infrastructure funds are on the rise. As an investor, we get to be a part of the global investment markets and benefit from the different opportunities presented.

….as is sustainability

It has been a joy to see how apparent sustainability has become in investing. Climate change is a strong topic today. Over 10 years ago, investors were urging managers to become PRI signatories and nowadays almost every manager has a sustainability policy, regardless of fund location. For ICT and service companies, climate change is not the easiest topic to incorporate into processes. Regardless, managers have joined the various initiatives, including Initiative Climate International (ICI), Science Based Targets initiative (SBTi) and ESG-related financing, without hesitation. The focus in infrastructure investments is mainly on energy transformation and each fund in Elo’s portfolio is committed to neutralizing the carbon footprint or reaching Net Zero.

Themes for 2022

Faster and bigger

Fundraising cycles in private equity have sped up and fund sizes have grown considerably. Best performing managers have managed to raise funds rapidly. The rapidly invested funds raise some concern of how sustainable the business models are as value creation is still under progress and only few exits exist to prove continued success. It remains to be seen whether those funds have been overpaid and whether the holding period withstands an extended lull in the economy.

New types of funds

New instruments and strategies are created to match the changing market. Continuation funds are becoming more common. A manager selects portfolio companies for the continuation fund from their existing funds with proven businesses where the risk compared to completely new investment is lower but return expectations remain high. Companies with solid cash flow and predictable business models are popular picks for the continuation funds.

Changes and value growth

Long-term effects of the pandemic on households, entrepreneurs, employees, and consumers are yet to be seen. Our environment keeps on changing. Strong performance of the stock market has persisted for long, although the fear of inflation has already taken a toll on the highly priced companies. A lot of value in private equity portfolios remains, and we expect the “harvest season” to continue.

Elo’s Private Equity investments per 31.12.2021

• number of funds invested 200
• number of portfolio companies 2500
• 4 005 million euros invested
• 42% profit