Silverfleet’s Chairman, Neil MacDougall, talks about the current ‘hotspots’ for alternative fund managers amid COVID-19 disruption
In this episode, our Group Executive Chairman, Serge Krancenblum, sits down with Neil MacDougall, Chairman of both Silverfleet Capital and the British Venture Capital Association (BVCA), to discuss the opportunities and ‘hotspots’ available to alternative fund managers against the backdrop of COVID-19.
While the pandemic has not spared the alternative assets sector, in all crises there are also opportunities. Neil shares his insights on the factors that have been driving the popularity of private equity and real estate. In particular, he talks about the ‘sweet spots’ that the private equity sector is well poised to take advantage of, especially in the light of accelerating digital trends, as well as the future of private equity and private credit following the likelihood of an increase in distressed debt in the current crisis.
Neil joined Silverfleet Capital in 1989, and became the firm’s fourth Managing Partner in 2004, a position he held until 2019, when he became Chairman of the firm. Having led some of Silverfleet’s most successful investments, including Finnish Chemicals and Sterigenics, Neil currently chairs the Investment Committee for Fund II and the European Development Fund. Neil is also Chairman of the BVCA, and with more than 30 years’ experience of investing in the European mid-market, his views and opinions are frequently sought by the media and industry alike. Prior to joining Silverfleet, Neil was a management consultant at Bain & Co, which he joined having read Natural Sciences and Computer Science at St Catharine’s College, Cambridge University.
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Welcome to the IQ-EQ Power Talk. I'm Serge Krancenblum, the Executive Chairman of IQ-EQ, and your host for today, I'm pleased to welcome our special guest Neil MacDougall, the Chairman of Silverfleet Capital and the Chair of the BVCA, the trade body for the UK private equity and venture capital sector. The COVID- 19 pandemic had a huge impact on the world's economy and the alternative assets sector has not been spared, but in all crises, there are also opportunities. Good morning Neil.
Good morning Serge.
How are you today?
Doing well, thank you. The sky is blue. The sun is shining. It's the middle of summer, and we've got a pandemic to talk about.
Yes, absolutely. But I see you're in good shape. That's great. If we look at last year's trends, investors appear to be gearing up to increase their allocation to private equity and real estate. In your opinion, what are the factors that have been driving the popularity of those asset classes?
Well, it's a good question Serge. There's no doubt that as of last year, the trend was very strongly towards alternative assets. In my experience, they're quite heavily correlated to stock market indices. So if you're a big fund manager, you allocate say 5% of your book to private equity or real estate, and as the indices go up, that 5% is a bigger number. So, you have that driving it as a source of the denominator effect in reverse effectively. The other aspect is that there were a lot of exits going on, lots of liquidity, lots of money flowing back to investors and people were quite keen to see that redeployed back into the asset class. So, good drivers from those perspectives. The way things are looking now though, we've got some interesting stuff coming. There's a Professor at the Saïd Business School in Oxford called Ludovic Phalippou who has recently published a number of articles and did a book about whether a product is actually generating a premium to what you could get off the US indices through a tracker. I think you'll see quite a lot of discussion over the next 6 to 12 months about does a private equity and do the alternative asset classes actually generate the premium that compensates for the illiquidity, with these vehicles. It's something that BVCA has been looking hard at, and I think the case is much stronger, certainly in Europe. If you look at the relevant indices for Europe, which could be the MSCI Europe Index, it produces about a 7 and a bit percent IRR. If you look at what the FTSE 100 has done over a very long period, it's about 7.7% IRR and, and private equity has generally produced a good premium, and by good, I'd say at least 300 to 400 basis points premium to those returns. If you look at America, it's harder because 20% of the S&P 500 is made up of companies which have performed this stunningly well, Amazon, Apple, Google, Microsoft, Netflix, and that's really driven a return on those indices that's well over 11% and has been on for a long period of time. So there's going to be quite a bit of debate about whether this is going to continue long term whether Phalippou who actually has a relevant point, whether it applies globally, now the liquidity it has gone, so the exits aren't going to happen, so investors won't be getting the same cash back. The denominator effect has come into play. So how it is looking for 2020 is really very different I think to how it was in 2019.
In terms of the investors we see more and more family offices also investing into private equity, but also there is a trend for only the high net worths wanting to have private equity and real estate as an asset class in their portfolios. Is it going to drive also the increase of the fundraising in those sectors?
I don't think so Serge, The weight of money is in the defined contribution schemes around the world. I think even as recently as last week, the US started to talk quite seriously about allowing schemes to invest in alternative assets. It's hugely controversial. There are people who hate the idea, but the pools of money in DC are just massive. If, for example, in the UK, the DC scheme started to access private equity, it would make a very significant difference. So family offices, I think unfortunately, will be very much on the sidelines in terms of volume of money. They're hugely important and very welcome, and if you're a General Partner and you have family offices in your fund, you love them to death because they are people that you can build relationships with. The Chief Investment Officer is likely to stay the same for more than three years and stuff like this. They are a nice part of the overall environment, I would say, but I think the big money moves will be DC.
Okay. We were speaking of opportunities as well, coming from the crisis. What do you think are going to be the opportunities now for the industry?
Well, the COVID crisis has accelerated a number of trends. I'll start with one, there's much more awareness of technology generally. Everybody who's been working from home has been using communication apps every day, in many cases for many, many hours of the day. It's causing people to think if you can do it this way, what else can we do this way? In things like healthcare you're going to see a significant investment in the interaction between the hospitals and doctors and their patients using these sorts of mechanisms of communication. You don't have to sit in front of the GP to actually have a discussion about how your health is. He or she doesn't have to actually sit right in front of you in order to take your vital statistics from you in terms of what your blood pressure is, There are even apps being developed which actually can test your blood pressure, just looking at your face, on a screen like this. I think you will see a very significant application of digital technology to a very wide range of industries, and this has accelerated that trend considerably. That's where I see a great opportunity. I think the difference between early stage venture and actually sizable buyouts will also get much more blurred in that the buyout organizations will be looking for emerging technology that, where I'm the personal investor in a company that uses smart software to monitor incidents in healthcare, and it's generating relatively modest revenue, but there are buyout organizations already starting to contact the management. That distinction between venture and buyout is going to become much more blurred as the buyout part of the market looks for technology and there will be a lot of technology coming through, so I think that will be a theme that will run for several years. It's really the application of stuff that's already been developed, but in clever ways in sectors that previously haven't really shown strong adoption.
What you mentioned regarding the blurred frontier between the private equity and venture capital and buyouts is definitely true because more and more VC funds also hold their assets for a longer period. They don't go for a listing over an IPO very fast anymore. They capitalize on the growth and try to have them at the different stages, and it's more and more the case. What do you think about the real estate, especially the investment in offices, because of the fact that we know that people can work remotely now. What do you expect there?
I totally agree. I don't think we're going to return to the way things used to be for a whole bunch of reasons, and part of it is that people have discovered that there are some benefits to being able to work at home, and that it doesn't have a significant deterioration on your ability to actually produce the output that you need to produce. That is one of the unknowns - exactly how big that's going to be and what the impact is going to be. I would not dispute that it is a trend that we will see. Building those hundred storey office blocks, full of people, I think that could be history in many cases.
And there might be, as well, a shift to smaller cities and not to concentrate everything in the capital, or in the main cities, because people will be able to go to local offices and still work as well.
Yes, absolutely. It could become decentralized, which would obviously take the strain off public transport as well, and of traffic too, so that it actually plays ultimately to the green agenda, which I think is probably the other crucial driver for the next at least 5 to 10 years. The areas where I think you'll see real interest is actually making buildings really energy efficient and really smart and not just paying lip service to those sorts of trends. One of the things that Silverfleet is looking at at the moment is new technology to make air conditioning and heating really smart in retrofits across Europe. I think you'll see people starting to go, well, maybe I should be a bit smarter about my real estate investment. Maybe I should be looking for what you might call a high quality building that I know is going to be used for a good reason, but I can make it much more efficient and therefore much more appealing to tenants.
This is also part of a trend that's going to be a real trend in the market, which is responsible investments that are increasing a lot in all asset classes. So, starting with listed securities, but now even for private equity and real estate, investors are quite in demand of responsible investment. Is it something that you're seeing as well?
Yes, I would say green equals responsible. I know of a major financial organization that has targeted 25% reduction in its travel. Now part of that is because it saves money, but part of it is also that they want to show to all of the stakeholders that they interact with that they have spotted and noticed and taken on board the fact that travel generally produces an awful lot of carbon dioxide and if it's unnecessary, why do it? And isn't it better for the environment and the world generally if you don't? So I think you will see much, much more focus on traveling only when you really need to - to close the deal maybe, to make that crucial first meeting with a customer maybe - but you'll see much more investment in other ways of interacting with your customers and building the relationship with your customer online. In a way you have to say the people who are going to suffer there are the aerospace industry, which has had a very long boom, the volumes, and you've seen it. Airbus is taking down build rates by a third, and it may well stay there, because there'll be much more scrutiny from a corporate level as to do we need to make that journey, make it justify why you're going to use up tons of aviation fuel to get yourself to that particular meeting. That's going to drive a lot of behaviour changes over the coming few years, and it's going to be big.
Absolutely. COVID-19 also has consequences on the debt markets and the private debt market. What is your view on that? What is your view on what's happening now and are there opportunities for the future?
I think we need to be really quite careful this time around. If you go back to the so-called GFC, there was a financial issue and the business model that emerged wasn't going to be very different to the business model of the company going into that crisis. So you could make it fairly simple assessment as to, is it a good company? What level of value should it have, a break in the debt, for example. In many areas that is much more complicated this time around because it's the business model of that company going to be affected or unaffected. In many cases, it's very hard to make that call right now, and it could be slightly affected, or it could be heavily affected, you just don't know. What's the real value of it? How easy is it to actually assess that? Now there'll be some opportunities actually where the business is not going to change massively, in which case you could go fine, well, I'm happy to buy in at this level, but if there's a sort of significant challenge to the underlying business model and where the outcome is uncertain, I would say be really quite careful as to what you buy into. My guess is that there'll be quite a lot of debt available in areas that people don't feel particularly comfortable about in the future. You've seen INTU is having trouble at the moment, the big UK property company, that's invested over many, many years in shopping malls and now people are going, do you know how much shopping is going to be done in shopping malls going forward? And what is the value of a shopping centre? If you're going to pile into something like that, I would say that's for the brave because the direction of travel has changed. It's not simply you went into a dip and came out in the same shape. You've gone into a dip and you're coming out essentially in a different way completely. There will be opportunities. There always are. There are people who've gotten themselves overextended who shouldn't have, but there will also be debt out there that people will just not touch, would be my guess.
As a last question, I cannot resist to ask you, as the Chair of the, BVCA some news about Brexit and what you think the impact is going to be on your industry?
Well, I'll tell you what our view is. First of all, it's pretty clear that the timetable will not be extended by the politicians. Not extending the timetable means that a lot has to be done in a short space of time, but frankly, it's going to have to be limited by the amount of time available. That means that what is likely to come is going to be as a pretty close relative to a hard Brexit. It may have the title ‘trade deal’, but the number of things covered by the trade deal may be quite limited. So the BVCA message to its members is yes, you've been very busy about COVID, there's something else that you need to remember is still coming at you as well, and that is Brexit and the implications of Brexit. I think it was four years, a couple of days ago, that the vote took place, so a lot of private equity investee companies have been aware of this change coming for a long time and have actually taken action, so I don't think this is quite as cataclysmic as people might write about in the papers. Behind the scenes people have been moving, preparing, applying to be authorized economic operators and stuff like that. But the message is, if you haven't done it, time is running out, and this time there are no extensions. You have approximately six months to get your house in order, and don't assume that anything good is going to happen. Assume that something close to a hard Brexit is where we're going to be. So that's the message. What's the impact? Well, I think a lot of the impact has already been seen, would be my take Serge. I don't think you're going to suddenly see massive changes in the first half of 2021. Many organizations have already made judgment calls about the impact on their business model and taken action.
Neil, it was great having you at our first IQ -EQ Power Talk, many thanks, and all of you stay tuned. Have a great night.
Great. Thanks Serge.