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Private equity to benefit if global equity markets are fully valued

18 Jan 2018

Predicting the future performance of global equity markets is notoriously littered with bear traps, so we look ahead to 2018 with due caution and a generous dose of humility. 

Cast your minds back to December 2006, when Bloomberg canvassed the views of 12 senior equity analysts at Wall Street’s largest investment banks and brokerages for their thoughts on the year ahead. Each and every analyst was upbeat and bullish. They said traders were experiencing ‘Goldilocks’ conditions, neither too hot or too cold, but just right, with volatility levels at 12-year lows. Their natural conclusion was that 2007 would be another good year in the markets.                                                                                

Yet just seven months later it began going horribly wrong as markets started to tank sharply. And after two more years, almost unthinkably, both Lehman Brothers and Bear Stearns would be out of business and other venerable Wall Street institutions, including the mighty Merrill Lynch, were ignominiously forced into accepting rescue packages in the wake of one of the worst Wall Street crashes since the great depression.

And so we tread carefully when it comes to stock market predictions. But daring to look ahead in 2018 and beyond, we support the views of respected international fund manager Jeremy Grantham.

In a note from last year, Grantham discusses the possibility of a market correction but only over the medium term. He points out that company price earnings ratio could begin to come under pressure from either lower company profit margins or rising inflation, or possibly both. But he was not discussing an immediate correction in 2018. 

Of course, major equity markets are still on a bull run that has lasted for nine years, with the FTSE 100 closing 2017 at record levels and the Dow Jones Index also closing 2017 near its peak having previously hit new highs no fewer than 71 times.

However, towards the end of last year we noted greater share price volatility affecting certain stocks after trading updates led to dramatic - and arguably disproportionate – price falls as investors took fright.

If we are reaching the point where individual stocks are fully valued these are more likely to be vulnerable to changes in investor sentiment.

On the horizon is US political uncertainty as President Trump’s White House struggles to turn rhetoric into concrete policies and laws. There are also the ongoing political and economic repercussions of Brexit, the war cries from North Korea and the responses from Asian and Western leaders as well as the increased flexing of muscles in the Middle East to factor in too. 

If markets are set for a period of volatility and price revaluations at some point this year or in 2019, private equity will be a major beneficiary as investors seek safer havens. Recent research on PE exits from AVCA covering 2007 to 2016 found that PE houses globally had a record year for exits in 2016 as they took advantage of favourable pricing. Given the amount of dry powder around at the moment, we foresee any stock market volatility next year leading to advantageous PE buying opportunities.

By its very nature, private equity is a longer-term financial commitment, usually of five to seven years or more, which enables our industry to deal with the economic and industry cycles, including swings and downturns that are inevitably part of any investing programme.

We believe that large, well-managed African infrastructure projects (power, ports, roads, large housing developments) will continue to attract global investors’ funds as they offer steady and reliable returns for those prepared to take a long-term view.

African demand for capital is clear, estimated at around $100bn a year for infrastructure projects alone. Without it, Africa simply can’t compete effectively in a global market. For example, currently the cost of moving goods through African ports is about 3 to 4 times more expensive than in Europe.

What’s more, the road access rate in Africa is well below global norms, and only a quarter of the roads in sub-Saharan Africa are currently paved, which means slower freight deliveries and also more frequent vehicle breakdowns and delays. These factors lead to high transportation costs which can add up to 75 percent to the price of goods in parts of Africa.

With such clear demand for new African infrastructure investment, we see transport and power as particularly exciting sectors in the coming years, given that modern, connected economies need power in every home. There are still around 600 million people in sub – Saharan Africa without access to electricity today.

Another factor that augurs well for African economies is the rise of the middle class with disposable income to spend on the consumer goods and lifestyle experiences that are common to developed nations.

You may be aware that Africa is the world’s fastest urbanizing region. According to research, there will be an additional 187 million Africans living in cities over the next decade, and by 2045, an average of 24 million additional people are projected to live in cities each years, which is larger than China or India urban population growth. Such enormous growth clearly requires considerable funding in terms of delivering new housing, transport and other services to these fast-expanding conurbations. 

If public equity markets start to come off peak, investors, whether from Africa or overseas, will be reassured that there are plenty of high quality private equity African infrastructure projects that could continue to deliver double digit returns over the longer term.

The best projects are identified by the most experienced investment teams. Teams who have built strong partnerships with companies and advisors across Africa, and whose local knowledge and contacts can filter out inferior projects before anyone’s capital is risked. These are our investment teams whose ethos is to leave absolutely leaving nothing to chance, with no proverbial stone unturned.

In conclusion, we respect the ability of stock markets to move rapidly in unanticipated directions. And if there is a correction at some point in the next 12 to 18 months, well-managed private equity offers a safer home for investors looking for growth in uncertain times. 

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  • Paul Boynton
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