The View from the Funds team - Q2 2022

News: Insight & Opinion | 9 May 2022

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In this current period of adaptation and adjustment, there are growing opportunities for private markets to step in and support businesses, and deliver strong returns to investors says Lorna Robertson, Head of Funds at alternative investment firm, Connection Capital.

In the aftermath of the global pandemic, the instability created by the Ukraine conflict and the impact of sanctions, elevated commodity prices, supply chain disruption, rising rates, and inflation – the consensus of opinion is that, in the near term, global growth is set to take a hit. This confluence of macro-economic and geo-political factors continue to force a rethink of the established world order. Crisis can be a catalyst or accelerant for change and most sectors have been impacted in some way by one or more of these issues.

Technological change and digital adoption across almost every area of our everyday lives will likely change the way that we live, work, learn, look after our health, and spend our leisure time. This was evidenced in 2021 which was a record-breaking year for capital raising in early-stage venture capital (VC) funding, leading to surging valuations and larger investment amounts, evident by the number of unicorns and decacorns established in the market throughout the year, with technology services and FinTech attracting most of the capital.

At the other end of the scale, traditional sectors such as high street retail, banking, travel, and entertainment, have all been under severe pressure and some will never return to pre-Covid levels. As fiscal support is gradually withdrawn and monetary policy is tightened, this will filter down to the businesses already feeling the pinch. Liquidity issues will be the challenge, putting balance sheets under intense, sustained pressure. The true barometer of this complex cocktail has been borne out in the public markets, where volatility has reflected investors’ sentiment as, seemingly, every piece of negative news causes a new shock and market correction. This may be an ongoing trend in the near term.

However, in this period of adaptation and adjustment there are growing opportunities for private markets to step in and support businesses, and deliver strong returns to investors. One observation I would make is that in the last year, the sheer volume of investment opportunities has increased and as a result, we have had the pleasure of meeting many new managers and exploring a wide range of new and extremely interesting strategies. Using our top down, bottom up approach to fund investing, here are some of the strategies and themes we think are worthy of consideration in a challenging market environment, for investors targeting diversification and investment growth.

Specialist credit strategies
Rather than looking at traditional lending funds, we have always sought more niche, specialist credit funds, managed by experts in their field, such as the BCI Credit Opportunities ‘lending to lenders’ strategy, which we recently re-opened to our investors, or the short dated, opportunistic SCIO European Secured Lending Fund, both are investing capital at an opportune point in the credit cycle.  

Connection Capital clients have also previously invested in the special situations/distressed debt arena, through global managers like Invesco Credit Partners and Blantyre, with a more European focus. We may look again at this sector later this year as the true impact of the events of the last two years begin to filter into the financial system and a new phase of the credit cycle unfolds.

Managers of these strategies specialise in identifying companies that are temporarily stressed, but are fundamentally sound businesses, which are unable to access credit from traditional lenders such as banks. In contrast to the more recent benign credit environment, there is little doubt that global distressed opportunities are set to increase. As the need for creative financing solutions emerge, many attractive investment opportunities and the potential for vintage returns for funds deploying capital at this stage in the cycle, will do so too.

In addition to the more complex and longer dated funding solutions, there is a growing need for more immediate solutions, especially in the absence of traditional bank lenders. We think that now may be a good time to consider debt investments in shorter-dated credit providers, which can help to fill funding gaps and assist good businesses through these tough times. Also worthy of consideration are managers that are specialists in debt restructuring, debt collections, servicing or providing hybrid capital solutions to businesses, working alongside them to get them to their next milestone.

We have also seen the emergence of venture debt funds, providing a less dilutive option to allow businesses to grow. Potential returns are attractive for the right sized funds, and it is an area we may consider in the future on a selective basis.

There may also be particular sectors for whom current challenging conditions are actually a boon to their business model. It’s important to be pragmatic here and seek them out.

The rise of digitalisation is impacting every area of our lives and we will be looking at the nascent asset classes that have significant growth potential. Our approach here will focus on specific sub-sectors, such as strategies associated with the middleware of cryptocurrency and blockchain technology, the metaverse and gaming. We will also be considering later stage de-risked growth strategies in more developed sectors such as FinTech, Consumer and Healthcare.

The key for us here is to be cautious about how we approach these sectors to minimise risk: to capture the trends without being at the ‘sharp-end’. For example, we would not consider investing in front-line bitcoin trading strategies, but instead we might look at strategies that invest in the infrastructure around cryptocurrency markets, such as those that invest in payment platforms.

The race to net zero
Net zero carbon strategies are another key area of interest, given that exponential growth is inevitable as the world finally turns words into action on climate change, and advances in alternative fuel sources, efficient battery storage and clean transport infrastructure come to the fore.

The challenge will be to back the real winners in a complex sector where the technologies are still being developed. With this in mind, we look for specialist managers who have always had a net zero, positive climate-impact focus and are science-led, rather than newcomers who may be jumping on the ESG bandwagon.

Similarly, sustainability concerns are creating opportunities in areas like food production, processing and agritech. Consumer habits are changing, and Silicon Valley entrepreneurs are turning their attentions (and their money) to the ‘greater good’ to find ways of reducing carbon emissions, while still providing enough food for the growing global population. As this happens, developments in innovations like synthetic plant-based or insect proteins and sustainable packaging should present a new frontier for potential investment.

Looking beyond sector and thematic specific investing, there’s a sense that fundraising has become more challenging, especially for early-stage or niche fund managers, as some investors ‘wait-and see’ and others, who operate on a NAV basis, are constrained by their own success from investing additional capital. This is prompting some managers to offer attractive co-investment opportunities on a fundless, deal-by-deal basis, rather than raising a blind pool fund, something that could provide our clients with access to attractive co-investment opportunities across a range of strategies going forward.

Additionally, the evolution of the private equity secondaries market continues. Our clients invested here previously with Headway and more recently, with the global manager, ICG, in their $5bn pure-play, GP-led, secondaries strategy. We anticipate further opportunities in this sector as the demand for both GP and LP led liquidity options continues and is no longer a ‘behind closed doors’ discussion constrained to an end of fund life option.

Looking forward to the second half of 2022, I remain optimistic that investing in private market fund strategies managed by experienced sector specialists will continue to offer strong growth and generate attractive returns for our clients and help to create a diversified alternatives portfolio. Looking at our current pipeline, this is an exciting time to be investing and I am looking forward to sharing these new fund opportunities with you in the coming months.