At the recent Houlihan Lokey Asset Management Round Table 2021, we heard from a number of experts on key topics of importance to managers and allocators on the current climate and how they are navigating the evolving market conditions. Here are some of the main takeaways from this webinar.
Equity Compensation
Asset managers, including long-only and traditional wealth managers, have seen a structural decline in their business, particularly when combined with the pandemic. The biggest concern now is downsizing and cost cutting. The private market space, specifically hedge funds and private equity, is doing well with the main concerns of managing, retaining and finding talent. Equity compensation is a way to get ahead of the talent pool and keep top performers. Some of what we see in the market is growth in minority GP stakeholders—generally, because founders with equity want to incentivize the next generation, so equity compensation within asset managers is becoming more prevalent. The reasons are clear; owning equity truly “incentivizes” people and gets them to act like owners who have “skin in the game.” You can see a direct correlation between firms you find on the “Best Places to Work” lists and those who reward employees top-to-bottom with equity. This has the effect of creating a positive culture within an organization.
Some key considerations with equity compensation:
- Incentivize the people who are going to drive growth.
- Succession, stability and sustainability often equate to how long people are going to stay, and are key factors for an acquisition, so approach equity compensation thoughtfully.
- Don’t be surprised that tension can arise between large and small shareholders.
- Determine how much liquidity and financing will be needed.
- Private equity and hedge funds sometimes include incentive fees; there are legal issues around giving equity compensation to non-managers.
Succession planning speaks more to the human capital aspect of equity-linked compensation for asset managers, hedge funds and private equity firms. Some considerations are more nuanced and should also be approached thoughtfully. Some key points:
- What is the vision of your next generation of leaders? What do they want to gain? If you spread equity too far (e.g., IPO) you will lose some people, and if too narrow you might lose others.
- It’s one thing to give someone equity, it’s another to figure out what the value of the business is and how and to whom that value benefits.
- Founders often say they want 100% ownership; but again, these are human capital businesses—buyers need others in the firm, so it’s necessary to spread out ownership to retain top talent.
- One of the biggest factors is how ready is the founder to let go of ownership?
- If the founder is ready to let go and wants a sustainable company, he/she should spread equity far and wide.
Private Market Investing
Allocators have been risk-averse, particularly during the early stages of the COVID-19 crisis, making it difficult for emerging managers to raise funds—even those with track records. The trend during the first two quarters of 2020 revealed allocations from real estate and energy being redirected into PE in order to drive additional yield expected from PE investments. It was noted that historical data indicates that PE has done well after recessions or a global crisis.
There is continued appetite for middle market investing where allocators are seeing opportunities for upside gains with the expectation of increased volatility.
With regards to liquidity, primary markets have been less affected by the COVID-19 crisis.
Large, established funds with existing relationships and track records have continued to garner allocations. Smaller and/or new funds have had difficulty attracting the attention needed, which leads to a drop in the number of funds receiving allocations. Price discovery, which was problematic in early 2020, has generally recovered in the early part of 2021.
Real Estate & Infrastructure
Despite the pandemic, deals are still happening at a fast pace. Specifically, technology and life science companies continue to increase activity due to the need for additional space. Additionally, industrial transactions exceeded office for the first time ever. Other sectors hit hardest during the pandemic, like hospitality, travel, multi-family, and self-storage will rebound faster. While the COVID-19 pandemic has pressured liquidity, there is ample opportunity for the secondary market to exceed where it was pre-pandemic.
Some other areas of opportunity include renewables, communications and digital—all long-term plays in infrastructure. Migration is putting pressure on infrastructure; people want to live and work in a more cost-effective environment and in areas with nicer weather, which puts more pressure on the infrastructure needs of those locations (i.e., roads, bridges, etc…).
Social assets will have a renewed focus, partly because of the need to be creative about new structures. For example, an infrastructure fund was cited as adding ESG on the label, which increased the value. The EU has also committed over €1 trillion dedicated to ESG initiatives.
To find out more about SS&C’s solutions for alternatives and how we can help you navigate changing market conditions contact us.
