Last week we hosted a webcast titled “Private Markets & Public Markets: Balancing Today’s Challenges & Opportunities” with Blaine Rollins, CFA, author of our popular Weekly Research Briefing and Mario Giannini, Chief Executive Officer of Hamilton Lane. We had several interesting questions come in from attendees, so we thought we would use this week’s blog to share some of their responses.
If you would like to listen to the entire webcast, you can access the replay here.
Question: What are you seeing on the valuation front today, and do you think things are overbought right now?
Mario: The number one question we get asked is, “Are valuations too high?” And the obvious subtext to that is, “They’re too high, therefore I should not be investing,” whether in the public or the private markets. And let me just say a couple of things about that. First, valuations are very high. It would be crazy to say anything else. They are probably at record levels in many parts of the private equity markets in particular. With that said, let me give you some context.
I could have made the same statement three or four years ago and probably had the same discussion three or four years ago, and valuations have moved up. It’s very hard to time markets just on valuations, particularly when you’re in the private markets and you’re buying companies for two, three, four, five years. Valuation is a metric, but it’s only one.
The other thing I’ll lead with before turning to Blaine on the public side is I was sitting with the CIO of a very large global investor, before the pandemic obviously because I was sitting with him in person, and he made an interesting comment. He said, “Mario, I’ve spent the last three or four years having people tell me that valuations are too high, and if you tell me that interest rates will remain relatively low, and that growth will remain okay or continue to grow around the world, then I’m telling you in five years, we will be having a discussion where valuations will be 50% higher than they are today.” And I’m not predicting that’s the case, but what I am saying is that, yes, valuations are high, yes, you need to be careful, but making a judgment on whether to buy or sell solely on valuations in the private markets is a very, very risky way to invest.
Blaine: And if you look at the public markets, they are definitely pressing against that outer layer of soapy film of the bubble. By most every valuation measure, they’re in the top decile. The one that stands out is maybe looking at the market on a cash flow basis, which it’s in the top half of historical averages, but that’s really only due to companies underspending on themselves and having lower CapEx and hiring costs today than they might normally have under a more certain environment and maybe a more certain political backdrop.
What I do think as we do emerge out of COVID and companies do see a reason to invest in themselves and expand. Then they’re going to take up CapEx and spending and add to working capital, and it might push that last measure out. So again, could the market move from 21x out to 25x forward number? Sure. We’ve seen that many cases in the past, but it’s going to take a very pretty Goldilocks to show up and keep stocks and credit from being super expensive.
Question: We are in an environment of really permanently low interest rates. What are your thoughts on it? Are they going to stay at these levels? Can you give us your broader outlook on interest rates?
Blaine: Yeah, I know. I know it’s a simple question. I don’t want to predict the outlook for interest rates at all. I don’t want to fight the current war of these inflation bumps or spikes, and this new wall of worry with respect to rates going up. I’m more in Jamie Dimon’s camp that I don’t want to own any treasuries anywhere. And like he said yesterday, he would even consider shorting treasuries here. So I don’t know if I’d go so far as to short treasuries, but I’d rather not play. If I need yield, there are other areas of the market to go besides just pure bonds.
Mario: I’m going to make a bold prediction. Interest rates are going to stay lower for longer than people believe. I think too many of us are from an interest rate environment that was abnormally high. We did a chart showing interest rates back to the 1600s, obviously using different countries. And essentially what you see is that the period — 70s to 90s, even the early zeros are the anomaly, that long-term rates have tended for hundreds of years to be closer to that 3-4% range, not what we think is normal, which is higher than that. You have long periods of time where rates are 2%. So I don’t think we’re at this point where it’s not sustainable, it’s not real, it’s not anything. And I’m guessing that we will be surprised at how low interest rates stay relative to what we all expect to happen.
Question: Moving over to private equity. Private equity fundraising is off to a very good, strong start this year, $180 billion raised in Q1, the biggest amount raised for first quarter fundraising since the global financial crisis. Do you think the private markets are too big? Or expanding too quickly?
Mario: I think I have to say no. Let me put it this way, because we’ve talked about this. The single biggest indicator people use of problems in the private equity market is the capital overhang. What you’re talking about, the amount of money being raised, and since you know I sometimes will use hyperbole, I will tell you it is the single most irrelevant indicator of what’s going on in the private markets. We’ve done all sorts of research around the correlation between fundraising, the amount of funds out in the market, the overhang and returns, and the answer is, there is no correlation. You would expect that fundraising would increase as markets get stronger. It’s just human nature. You invest in funds, you put money, you feel better. The real question is, how quickly is that money being spent? I will say we’re beginning to see some indications that the money is being spent faster.
In the last 10 years private equity has been investing slowly. General partners, people investing have been worried about valuations, and they’ve been pulling back. We’re beginning to see that loosen a little bit, people getting a little more confident or worried that they’re going to miss the next move up. But the amount of money out there, I would urge everyone listening when they hear that with the phrase, “It’s a problem,” change the station. Go to the next commentator. Really listen to, “Are they spending it quickly? What’s going on with the money they have?” That’s the real critical question around that. So I would expect this year, by the way, to be a record fundraising year in the private markets. I think, given people were a little hesitant last year because of the pandemic, people are just now going to commit quickly and people are coming back to raise capital. So I would fully expect this to be a record year.
Question: And looking to the public markets. Do you think it is harder to create alpha in today’s environment and with fewer public companies?
Blaine: That universe that Mario was talking about, the Wilshire 5000 has been reduced from 7500 companies 25 years ago down to 3500 today. And those 3500 have some mega caps in there that really skew your ability to get exposures in the equity markets that you might want to. So it is more of a challenge. If I want to go and find some companies, it’s Earth Day, so say specific to plant-based foods or plant-based nutrition, there’s just not that many companies in the public markets that I can go and buy, and I’ll probably end up having to buy a stock like ConAgra or one of the major food companies that alternative foods might be less than 5% of what they do today. Whereas in the private markets that have seven times the number of global companies versus the public markets, I could go and put together a whole big basket of alternative food companies all around the globe or within a specific country, to pick the exact bet that I want to make and hopefully get that alpha that we all want to create. So it’s definitely become more of a challenge having fewer companies out there.
Question: ESG and impact investing: Is it a trend, or do you think it’s here to stay?
Blaine: It’s definitely here to stay. I was on a call yesterday with the CEO of Ryanair, and he runs probably Europe’s most successful airline. And you just hear him talk about the changes that they’re making and how they’re playing in on the future. And I couldn’t imagine starting a company, an old line company, today from scratch, yet you have to take into account all these ESG measures on where are you going to get your fuel from? What sort of engines are going to be in your planes? It’s very difficult to manage a very large company without running into ESG and all of its components today. It’s not only going to be with us from our existing companies that we own, but any new company that comes out, anybody that’s getting on the train, it’s more attractive, it’s more interesting and hopefully very, very profitable.
Mario: I agree with Blaine, it’s not a trend. If it’s not the most important development over the next five to 10 years, it’s number two, and I’m not sure what number one would be over that. You will not be able to make an investment without an ESG lens, I think, going forward. And in many cases, it will be the most important lens. Particularly in many parts of the world, the “E” component, the climate change impact. In the private markets when you think about holding an investment three, five, seven years, think about investing in fossil fuels of any kind today. Let’s say you thought the price was low, and it was going to go up, you have to think about where you are selling that asset in five to seven years, and that is a really problematic question.
It’s like coal 10 years ago; it may have been very cheap, but where are you going to sell that asset? And that’s just one example. That ESG lens is having an impact on what is the future of your ability to do anything with that asset however attractive it might be today. So I believe that people will both have existing portfolios that have that ESG lens and will have portions of their portfolio that are specifically aimed at, again, the “E” component in particular, as governments put more emphasis on that, as social pressure puts more emphasis on that, and as consumers put more emphasis on that, as part of how they make their choices. I think this will be a natural part of conversation, if it isn’t already, very soon.
If you want to hear more, we encourage you to view the full webcast for more insights from Mario and Blaine.
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