With the era of cheap money consigned to history, risk management is set to be a top driver of private equity investment returns. Haakon Blakstad, Chief Commercial Officer at Validus explains how the company’s track record in managing market risk over more than a decade, combined with a global presence, makes it an essential partner to PE funds…
Can you outline the industry trends which have been driving growth and development within your firm over the past year?
Several seismic events have brought the importance of effective risk management into sharp focus in the past 12 months. The big catalyst has been persistent heightened inflation which, despite over a decade of low rates and excessive money supply, still took many by surprise. Few finance professionals have experienced sudden interest rate hiking, and many have never experienced high interest rates at all.
Firms across all industries are having to contend with increasing levels of risk, making continuous growth harder to achieve. For private equity this means having a clear picture of exposures and potential risks is more vital than ever.
Demand for specialist advice and technology solutions allowing managers to better understand, assess and manage risk is increasing as a result. Clients are being proactive in wanting to get ahead of potential issues, instead of reacting when it may be too late. In terms of market risks, over the past decade we have seen a slow but steady demand for advice in managing currency exposures, and more recently heightened demand for interest rate risk advice too.
How have client needs and demands changed, and what has your response been in terms of your service offering?
We have expanded the delivery of our best-in-class advisory, outsourcing and technology solutions. To cater for a surge in demand from new clients for currency and interest rate risk management. Reduced supply in subscription line facilities and a fast-evolving (but complex) market for NAV lending, has also brought increased demand for Fund Finance Advisory services
The needs of our existing client base have evolved too, with operational efficiencies becoming an increasing focus. Instead of growing headcount, many are exploring how their existing advisors and solutions providers can help with monitoring, reporting, compliance, and general administration and we continue to develop our technology to automate many of these tasks, while also working with clients to take on certain outsourced activities.
What is your outlook for the private equity space for the coming year and how is your firm best placed to support clients navigate the environment?
Despite the new economic reality, increased market risks, and tighter funding conditions, we have a buoyant outlook on the PE market. M&A activity may have slowed significantly, but we do expect firms to increase deployment of their dry powder in the near to medium term. Private equity can help portfolio companies navigate choppy waters, but that doesn’t mean everyone will succeed, and we are expecting to see a larger gap between top and bottom quartile funds.
We are particularly well-placed to support firms through evolving market conditions, ensuring that they capitalise on opportunities while navigating and managing risks, which will be a key driver of performance. PE funds will continue to look for cross-border opportunities to increase diversification, which will create currency risk and volatility in both NAV and performance.
Leverage will continue to be an important tool, but the current interest rate environment means debt has to be more carefully assessed and structured, and the risk of future rate hikes has to be managed.
Could any shift or change influence the potential growth in the industry?
The era of cheap money is over, and while inflation may dissipate in some areas and rates could recede, markets are unlikely to return to how they were before, and during, the pandemic. How local and global economies react to the unprecedented rate hikes we’ve seen (and continue to see), remains an unknown, but whatever the outcome – severe downturn, soft landing, or somewhere in the middle – the industry will be impacted.
Despite tough conditions, private market allocations have continued to rise in expectation of outperformance versus their public equivalents. Due to the more challenging investment landscape though, we think the gap between winners and losers will widen.
Can you list three key learnings you are passing on to clients in the current environment?
Treating market risk management as a top three driver of investment returns is key to maximising the chance of achieving high performance in the current environment, so all PE firms should:
- Assess: Understand exposures to market risks such as currencies and interest rates and quantify impacts to individual investments and the overall fund. This is a complex exercise, so seek specialist advice as turning an unknown unknown into a known unknown has value. Recognise that by leaving an exposure unhedged or unmanaged you are taking a view and speculating that this risk will somehow benefit you.
- Prepare: If your investment strategy does not expect a reward from such exposures, start devising a process for managing and mitigating these risks. Create policies and assign responsibilities; establish hedging infrastructure; leverage technology from the outset; and work with specialist firms to adopt best practices.
- Act: Implement policies and procedures rigorously. Adapt to market changes or deviations from investment models and ensure that risk management performance is monitored as closely as investment performance. Avoid key man risks, prioritise scalability, and always seek to improve efficiencies. Outsource if you don’t have the necessary in-house expertise and resources.
Haakon Blakstad, Chief Commercial Officer, Validus
