Home Alternative Investments Mid-caps in digitization have strong upside potential: Partners Group

Mid-caps in digitization have strong upside potential: Partners Group

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David Layton, CEO of Partners Group (Courtesy of Partners Group)

Global fund manager Partners Group Holding AG, one of the largest listed private equity firms in Europe headquartered in Switzerland managing $147 billion in assets, is eyeing opportunities in promising mid-cap companies that have upside potential of increasing value, consolidating peers and creating meaningful changes in global industries.

The investment manager has focused on a roll up strategy, or acquisition of smaller companies in the same industry to grow businesses, with a focus on sectors that benefit from digitization and automation, over the past several years. The firm prioritizes finding and expanding the value of companies in this way. 

Located on a hill in Colorado, its US headquarters has a sign ‘This is not Wall Street’ and the firm bans using the word ‘deal’ in the office to highlight the industrial and business founder’s mindset that is its hallmark.

Partners Group opened the Seoul office in 2010 and has raised around $5.1 billion from more than 35 South Korean institutional investors such as National Pension Service (NPS) and Korea Investment Corporation (KIC). David Layton, who became the sole Chief Executive in 2021, visits Seoul every year to discuss investment opportunities and market outlook with the firm’s limited partners.

This is the transcription of interview with Layton earlier this month in Seoul.

What are the recent changes in the Korean and global private markets investment scene?

“In the Korean market today, people are focused on liquidity and getting their capital to work quickly via private equity secondaries. In particular, they are interested in mid-cap firms which can provide more opportunities to quickly transform the business with good risk-return profiles.

From a global perspective, depending on the segment of private markets, you saw a 40%-65% decline in activity levels over the past two years. I think that is largely a result of people needing to change and regear the types of investment opportunities they were looking for.

In the past, people were more focused on real estate or leveraged buyout investments. Today, you see more of a shift towards interest into secondaries that provide early liquidity or into credit investments that offer a stable stream of cash flows.”

There is a general optimism that interest rates have peaked and will decline this year, but market uncertainties persist. How do you expect the global private market activities this year?

“The financing market is starting to come back and looks more robust. The Federal Reserve’s signals on stable rates will give a lot of investors comfort that the very negative tail risk scenarios are perhaps off the table. We believe that there is potential for reasonably robust levels of investment activity in the next 12 to 24 months.”

Partners Group’s US headquarters in Colorado (Courtesy of Partners Group)

What are the particular risks to be highlighted in the markets this year?

“Competition in private debt markets have been fiercer as investors flock into the asset class in the high-rate environment. As covenant-lite loans increase, private lenders are facing more unfavorable conditions. Higher debt financing costs for leveraged buyouts can also hurt returns.

Although secondaries are a good strategy amid market uncertainties, there are many assets for sale, too – transactions of secondaries globally increased 15-20% last year, which means there are more sellers competing to exit.

It will also be challenging to divest real estate if interest rates stay at a high level for a few years from now. Real estate, depending on property types and capital structure, could be very sensitive to changes in interest rates.”

What are the asset classes and strategies that you believe to be promising, and how does Partners Group prepare for upcoming opportunities?

“We see infrastructure growing at the fastest pace among our asset classes and this trend will continue over the next few years. Our private infrastructure logged a 19% five-year compound annual growth rate (CAGR) by the end of the last year, compared with 13% for private equity, 11% for private debt and 4% for private real estate. 

You get some cash flow and yield from operational – or core – infrastructure assets, but we also have the ability to roll up our sleeves and actively transform or build substantial infrastructure platforms via a value-add approach. We use our private equity skillset for those infrastructure assets.

By strategy, more investors are interested in value-add. A lot of investors romanticized a core strategy, but they have found that the theoretically safest investment opportunity presents risks in other ways. People’s capital is locked up because there are fewer opportunities to divest today.

We focus more on themes than sectors – for example, we believe digitization and automation are significantly transforming businesses. It is one of the three giga themes underlying our thematic investing approach, alongside new living and decarbonization & sustainability. Mid-cap firms stand out as they can transform businesses, expand into new markets and become market leaders relatively faster than large caps.”

What is an example of Partners Group’s portfolio companies in the digitization and automation theme?

“One example is Surewerx, a mid-sized firm manufacturing safety equipment in North America. Before we acquired them in late 2022, they had good products but hadn’t fully invested into systems and technology.

In order to accelerate the firm’s growth rate, we have helped them build out their data, analytics and technological capabilities and invested into the digital connection with their customers, so that the order process can become more automatic and cost-efficient. We are also helping the company expand its product offering, and professionalize their sales efforts by taking the best-in-class sales techniques that are working for us in our other portfolio companies.  

Another example is that we have acquired Dutch conveyor belt manufacturer Ammeraal Beltech and Italian belt producer Megadyne and merged them into a single portfolio company, now called Ammega, via a roll up strategy. We invested into automation without necessarily having to pay very high prices by investing into the consumable side, and hence we found better value and attractive growth rates. We leveraged their combined strengths and effectively created the dominant European player.”

So Partners Group focuses on building value of companies by expanding its business and influence in industries. 

“Yes, and that is why I think we are more like an industrial conglomerate than an investment firm. We have controlling stakes in about 60 companies with $100 billion of combined value and focus on helping a business reach its potential, get more efficient and better position itself strategically against its competition. This is how we differentiate ourselves from typical Wall Street firms.

We even banned using the word “deal” in order to shift from a transactional to a more industrial mindset. We encourage our staff to behave like entrepreneurs rather than financiers.”

David Layton, CEO of Partners Group (Courtesy of Partners Group)

You said more investors are concerned about liquidity today. How does Partners Group respond to their demand?

“We have offered evergreen funds, which are open-ended vehicles with limited liquidity features, to institutional and individual investors for more than 20 years – we have $43 billion of our assets under management invested in such products. In closed-end funds, you take several years to make investment decisions, commit capital and get exposure to markets. Within open-ended structures, you can have immediate exposure, flexible exits and more customized solutions – we build a portfolio tailored to clients’ net asset value (NAV) target.”

Many Korean investors prefer closed-end funds. Do you expect this trend will change?

“We see more investors outside of Korea seeking exposure through open-ended structures and you might see this trend come to Korea significantly over the next couple of years. Open-ended funds’ target return could be 10-12%, compared with closed-end funds’ target of 15-18%. But we believe more investors in Korea will use this structure for its liquidity, flexible duration, and customized solutions in competitive markets.”

How do you expect limited partners’ needs for tailored solutions will affect asset management firms?

“There will be significant consolidation in private markets. There are 11,000 private markets firms, but many of those firms don’t have strong differentiation and only 26-27 firms raise almost half of total capital in the markets. Those general partners who fail to raise capital tend to focus on selling financial products, rather than building customized solutions.

Many large institutional investors in the US and Australia have started decreasing the number of asset managers they invest with to instead focus on tailoring a bespoke portfolio, and I think this will come to Korean investors who still hire a relatively large number of asset managers.

This change is similar to what happened in the stock brokerage markets in the 1990s. A large number of stock brokers were replaced by fewer big institutions with systems that owned different corners of the markets by around 1995.”

What is your investment philosophy and how does it relate to Partners Group’s identity?

“I believe that investing requires a team perspective. To be differentiated from others over a long period, you have to build a team culture and platform where people work together and share their views very actively. We are not hierarchical and allow people to freely exchange their opinions. I think this is similar to the approach to politics in Switzerland, where we are rooted.

We aim to sustain our differentiation by strengthening our portfolio companies’ value. This is also reflected in our Colorado headquarters’ architecture, made of bricks, steel and stone, which feels industrial. We keep in mind that building businesses and creating value should be our focus, not transactions.”

Write to Jihyun Kim at snowy@hankyung.com
Jennifer Nicholson-Breen edited this article.

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