Where this $100b private equity guru is hunting

Fred Pollock, of US private equity firm GCM Grosvenor, says bargain hunting in a tumultuous environment can be a trap.

You get the feeling it would take a bit to ruffle Fred Pollock, chief investment officer at Nasdaq-listed alternative investment manager GCM Grosvenor.

Asked for a comment on a wild few weeks on global financial markets, Pollock is measured. History doesn’t repeat, he says, but it does rhyme.

“There’s a lot of things that are going on that are not new. What’s unusual is a combination of those different things happening all at once.”

Grosvenor, which manages $US72 billion ($97 billion) in alternative assets, specialises in mid-market private equity investing and is the manager of local fundie Pengana Capital’s ASX-listed private equity trust, which raised $75 million this month to chase opportunities in a rapidly changing market.

But Pollock emphasises that he’s not about to go bargain hunting among companies struggling in the current environment – buying a poor company that is 30 per cent cheaper than it was still means you’re buying a poor company.

“I’d rather figure out how to invest in higher-quality companies at fair valuation than traffic in distressed companies,” he says from his US base.

“Because, traditionally, we’re holding these things for half a decade to a decade, and you want to own high-quality businesses that can grow and compound over that period of time.

“I would say – and it’s the same as it’s always been – which is, you need to be investing in the best stuff because the top 25 per cent vastly outperforms the other 75 per cent in private markets.”

Private equity turmoil

But that’s not to say he doesn’t see opportunity in pockets of pain and a world where inflation is clearly rising and capital is likely to become more scarce.

The turmoil on public markets has been worst in sectors where private equity is a relatively small part of the market, such as technology, healthcare and biotechnology.

As such, Pollock believes valuations in private equity – where companies are typically cash-flow generative, have a sustainable competitive advantage and trade on low double-digit earnings multiples – have held up relatively well.

But where public markets and private equity to intersect is in the provision of capital.

“There are a number of private companies that are growing, and growing quickly, and they’ll still need capital, and I think the public markets are going to be less welcoming to those companies for some period of time. And that should present some interesting opportunities.”

Pollock says Grosvenor is considering several opportunities to provide structured finance to high-quality companies where existing investors won’t, or can’t, provide fresh capital, for whatever reasons.

Sometimes this will be more plain vanilla credit, but Pollock says Grosvenor will also look for opportunities where it can share in future upside through convertible instruments.

Some of those overbought sectors of 2021, such as tech and healthcare, are catching Grosvenor’s eye now, but the firm’s investment selection rate of less than 10 per cent looks unlikely to rise in the current environment.

“We’re just making sure that the businesses have some form of pricing power so that they can sustain themselves – pass through costs on the revenue side, and have their cost structure under control in an inflationary environment. Because we’re certainly in one.”

That said, Pollock expects 2022 will be an easier year to deploy capital, with the frothiness of 2021 replaced by a degree of circumspection.

“When things get really frothy, it’s not good because you get too many entrants and too much capital is wasted in the sector.

“I think people are going to be more measured and circumspect. They’re going to be more conservative with what they put into their models and a little less aggressive with their financing and their bidding.”

Rock-bottom interest rates have been a major driver of funds into alternatives, but with central banks now hawkish, could the flow of capital to sectors such as private equity slow down?

Pollock doesn’t believe so. Even after this strong growth, he argues the size of the private capital sector is not out of whack with the size of the private markets. And inflation should keep alternatives attractive.

“At the end of the day, you’re still stuck within a relatively expensive public market and a very low rate, or negative real rate fixed income market, so alternatives are kind of the place to be because you need to generate excess return on your capital.”

View the original AFR article HERE.