Course Correction: Reflections on Financial Frenzy

[Music] everybody I'm going to start off with a bit of good news um we were originally going to be four panelists um uh not including myself we're down to two and I know how much the organizers will appreciate this but we were running a little bit behind the schedule so I'm going to give us some time back so we're not going to speak for the 25 minutes um that we were due to be speaking we're could to probably speak for about 15 minutes plus a little bit um now um the private Capital Market as we all know has been through a decade plus of explosive growth so is about $23 trillion worth um spread across the private Capital markets at the moment uh by contrast a little over a decade ago that was less than 10 trillion what we're going to do today and we've got we're going to split this into kind of two bits the sort of the the the equity component private Equity um and venture capital and as it is related look at kind of what has happened um what were the drivers that got us there but specifically what's happened just most recently um we're looking at the turbulence and and and asking that question you know is this just a bump and we go back to how it always was or is there just something very very fundamental that shifted here um and we're going to look at the same in private credit where there's just been um some um uh sort of explosive growth there in fact it is probably the hottest of the hot sectors in private credit um over most recent years so we're going to divide it up um that way a little bit but um but Kate let me start with you then on the equity side and I know you know your Association looks less at what sort of um the most developed markets I'm choing my words carefully because I know you don't like the term emerging markets and I'm sure you're going to tell us why um but let let's just sort of understand what's been happening in say the past 5 years we had had that term fear of missing out there's no doubt about the wall of money that was thrown at private markets number of different reasons for that perhaps you might want to cover those um but but the era the era of cheap money was a big driver for that so where are we kind of now but what were the drivers that got us there that people were afraid of missing out of and then kind of what does a reset look like now right that has happened in the past 12 months well I think you know it's no secret we've seen um 20 years of a dramatic increase in private Capital activity globally but particularly you know in the US and with 0% interest rates and um leverage um readily available um you know Financial engineering drove a lot of the the profits and the returns that we saw uh out of out of the US um it's going to be a much more complex environment going forward and I think that there um anyone who's predicting a return to normal is going to be sadly disappointed I think there is no normal sort of waiting on the other side the scale of capital to be invested globally um you know it's about 1.3 trillion that's raised just by private Capital fund managers each year but in addition to that you've got to take into consideration all of the Sovereign money not only from this part of the world but from places like um Singapore can you've got Canadian pension plans you've got all of the billionaires that have been minted in in past generation so um all of that capit is you know it's a challenge to put it to work and and you're right um my organization was founded as the Emerging Markets private Equity Association um in the early 2000s by the IFC at the World Bank I've been hearing this terminology Emerging Markets referenced again and again this morning um I don't know why I mean so often language is the enemy of understanding and doing things well you can't Define 88% of the world's population is emerging China is the world's second largest economy um I leave New York where I live and see digital payments light years ahead of where we are in the United States in in Asia and other parts of the world um I also see infrastructure that's far more advanced than we that we have in the US you look at where wealth creation comes from frankly who's here in in Abu Dhabi this week um I think that there is a fundamental shift underway and so what I would highlight in terms of looking forward is in the markets that we cover in Asia Africa Latin America the Middle East Central and Eastern Europe um Financial engineering has never been part of the Playbook there is no leverage in those markets and I think everyone's predicting in the US and globally operational capabilities are going to be absolutely key to delivering returns going forward and I would argue that there's a much better opportunity to put money to work productively uh in other places uh outside the US and Western Europe today um just from the place that we're starting from thank you and so we started off today with um presentation on the 10 rules of what makes a successful Nation I just you know given that um you know where you look at um you started off in Latin America but uh within the Emerging Markets or not depending what term we use where are you seeing it from your members where are they finding the most interesting opportunities uh amongst those developing um economies at the moment and did they match up with the results that we saw I love that you're asking me that it's a great question I'm going to throw it out completely no one thinks about investing that way anymore it's not about geographies you don't say institutional investors don't say today I'm going to put 10 in Brazil and 20 in India what they think about is thematic investing and the major driver of deployment of capital today is um the climate crisis and the opportunity to back the energy transition this represents an opportunity to put trillions and trillions of dollars to work not only in um new sustainable infrastructure and the energy transition itself through Renewables but the reinvention of manufacturing food and aggra business I mean there's an enormous amount of capital that needs to be invested where can you do that most productively where do you find the managers the fund managers that are responsible for delivering that performance so who do you trust in the market that you're investing in and then the other big theme is everything related to technology digitization and Innovation um you know I've got another panel after where we're talking about healthare and Life Sciences I mean AI is going to drive apparently just incredible Innovation and what we're going to see in life sciences going forward you have places like India where they've created UPI um the government has created this a universal payments infrastructure that is driving you know massive investment um in in fintech which is one of the big thematic drivers going forward as well there's another example in Brazil with pix which was created by the Central Bank uh of Brazil so fintech um climate um healthtech digitization of traditional businesses private credit which I'll let my you know co-panelist speak about um you know it's much more sectorally focused rather than um geographically now we'll make one exception which as we know there's been a massive shift in China and there's a reorganization of Supply chains going on globally I believe some of the other panels may have addressed this so for sure we had see shifting private Capital flows um with a shift in China the opportunity to reorganize Supply chains and a focus on India in many cases now I mean I think I think there are some um some geographical themes you can pick up on particularly around the demographics of where you're more likely to find entrepreneurs and indeed consumers of new and Innovative products but um uh but Point well taken um let's switch really to private credit and um an area that I know uh a little bit about given that my Association um also um uh covers private credit and we we've WR a report recently where we have um predicted that private Credit in fund form will overtake private Equity um by the end of um end of this decade if not very much before so it has grown enormously at what we're approaching $2 trillion dollar worth of um AUM in in private credit funds you know what you're doing is somewhat different you're an entrepreneur first and foremost you created um BS to credit but what you are doing is you are lending to smmes tell us a little bit about what um about both about your business what it was like being an entrepreneur setting it up and actually whether um uh in this non- new normal uh it would be more difficult now as an entrepreneur to set that up yeah so I think uh there are two things so as an entrepreneur when we set up bills to credit uh there was a lot of VC money SL private Equity money and not much private CR you know credit 2008 was a trigger point because of regulatory pressures when you know private credit Market started coming in but because of money being so cheap you know people were looking for returns and Equity was much better than you know private credit last 3 4 years we have seen a major shift already starting to happen even before fed starting increasing the interest rates there was a recent McKenzie report which said that 75% of new credit uh has been created outside of the banking system which is massive you know shift because most of the credit was deposit money or bonds 81 bonds and other things you know that Banks were doing and I think there are three or four big reasons and the FED interest rate increase has just accelerated that you know phenomena one obviously after 2008 you know a lot of banks withdrew from a lot of lending piece of the business especially in the space because Basel 3 came in and other regulatory aspects came in and banks are not just equipped doing it the second thing is banks have been behind in digitization covid has accelerated the whole you know the digitization of the customers the businesses everybody and banks are just you know now trying to catch up with that so what was regulatory Arbitrage for a lot of banks has become a big disadvantage what we are seeing in us and my experience has been that what starts in US spreads across the world it takes some time is that we are going to see a massive amount of consolidation of banks now especially Regional and super regionals their cost of deposits have just gone up to 6 6 and a half% now if I take into account Branch networks it infrastructure cost and they cannot lend money at more than 9 or 10% because they're not used to that their models will not allow it their technology doesn't allow it and that whole spread that they used to have like 6 7% spread has now shrunk to 3 3 and a half% kind of a spread at a gross level and what is happening with private credit is fascinating because a lot of people are moving their money out from bank deposit deposits and putting it in other instruments because everything has gone digital and online and that's where you know and especially insurance so as the Western World ages as longevity goes up a lot of insurance money has to now buy the assets which can match their liabilities and that's where you know somebody like say Apollo when they transform themselves from a private Equity player into a private credit player with the acquisition of say aen and that started the whole process now not many people know but today Blackstone k you name any big private Equity Firm in us you know they have bought a stake in a insurance company and they're moving dramatically over to private credit business few reasons less regulated better returns with increasing interest rates you know the return returns have gone up Equity markets have softened a lot especially both public as well as private markets and if you can get a return of 13 14% so what we are seen in our businesses that when we started the business you know we used to fund small business or customers who were who used to go to a bank first if they didn't get money or a loan or a lending product then they used to come to a player like us now it has turned upside down so much so that you know we have so much private credit money insurance money pension fund money endowment money also starting to come in and as the world has gone digital people are more willing to share data now ai is going to accentuate it even further and the biggest change that we are seeing is that Banks themselves are struggling so they are coming to us now and saying that we need Capital relief so which is like your Banks coming to players like us and saying that we need access to Capital because we cannot keep lending money to our own customer base and we cannot afford to lose them also because if we sell those portfolios we're going to lose them now that's a very interesting paradigm shift I foresee this is going to just Accelerate from here and private credit is going to become a much much bigger part because if the interest rates are going to be where they are for next 12 to 18 months months you know the market will totally shift away so that's here to State can I just ask a quick question about kind of risk because um for borrowers to Service uh debts in a higher interest rate environment when you look at your loan book as it were um have you seen any material um change in the credit quality of that are you having to do a lot more work on restructuring with your borrowers so what we have seen is the US economy has held up pretty well till now having said that what we always see is that when there is so much of capital available one way or the other people make mistakes you know there is a fear of missing out people will start lowering standards they will start you know originating more or buying more of these loans and that's where the crisis really starts so I think we're still in early stages of that having said that private credit Market is very lightly regulated you know compared to Banks so that's a risk that's there and my view is that if we keep seeing interest rates at this level for a extended time period Then yes we will see uh some blowups will also happen and I think the other Big Challenge would be that lot of private credit funds that are getting Now set up you cannot do it with the mindset of private Equity it's a very different business you know so that's where it's not like you can have some hits and some misses and you can make some outsized return from few of your investment it's a more steady ongoing kind of a business where you have to be very disciplined and also think that you know how can you get the money back in a Time bound fashion because if it gets delayed by 3 or 4 years then your returns to your LPS is going to diminish quite significantly good I see we have come um right at the end of our um uh our time then i' promise to give some back but I just want to ask you Kate one last question and you know I think really picked up on the fact you know we're not going back to any sense of normal of how it was before and I um I think mcken there was a McKenzie report I was reading saying the music and this is specifically private Equity that the music hasn't stopped uh but it's been turned way down I wonder if that needs an addendum to it and whether you would agree um that actually not only that but it's perhaps the radio has been tuned to a slightly different wavelength which we better get used to from here would you agree with that well I guess you know two large observations one time Horizons have changed so fundamentally in terms of thinking of a three or five or even a 10-year investment Horizon those Investments Horizons are getting pushed out longer longer and longer and then of course you have all of this institutional capital from places like Singapore and in the Middle East where they don't think in terms of again a five or a 10-year Horizon but they're looking decades and decades out into the future and if you're trying to predict what to invest in and thinking about the the return on that Capital the risk of that capital in a 20e horizon it's it's very different from thinking about what am I going to make money on today and what will I be able to list or or exit in in the market today so that's that's certainly and then the other one would be the relationship between institutional investors and fund managers more and more institutional investors are investing directly they're co-investing so the relationships between GPS and LPS is fundamentally changing and um you know I think there'll still be a piece of that that will that will stay in place it's not like the industry is going away by any sense of the imagination but I think trying to brige Simply you know what's coming in the future based on the past is a a Fool's game excellent listen I think we'll have to leave it there okay R thank you very very much indeed I know it's a bit of a a Gallup through um but I really appreciate your time thank you thank you it was wonderful to be here