Assessing opportunities across private markets

Andrea Picard:  Hello, everyone, and welcome to the breakout session Accessing Opportunities Across Private Markets.  It’s a pleasure to be your host today.  My name is Andrea Picard and I lead the Pensions East team within our Institutional Client business.

On the eve of the COVID-19 pandemic, BlackRock’s view was that private markets should play a sizeable role in overall portfolios and there was room for many clients to have even larger allocations in private markets than they currently do.  Despite valuations being rich across some private asset classes, our view was that many clients could assume more liquidity risk than they realized when looking at their total portfolio.  Return expectations for private markets, coupled with alpha potential relative to other opportunities justified that view.  In a world where rates are low and growth in income are scarce, incremental return and alpha have a meaningful impact on portfolio objectives. 

This pandemic has changed the world in so many ways.  I want us to stress test that with our panelists, whether the logic still holds, as well as discuss what clients should be focusing on within their private market portfolios today. 

With that, it is my pleasure to be joined by some incredible investors on the panel.  First, Anne-Marie Fink, Managing Director, Private Market Funds Alpha at State of Wisconsin Investment Board.  Next, Lynn Baranski, Global Head of Investments for BlackRock Private Equity Partners.  And lastly, Jim Barry, Chief Investment Officer of BlackRock Alternatives Investors.  So, let’s get started.

So, Jim, let’s start off with you.  You have a unique vantage point into private markets as a whole as the CIO of BlackRock’s $21 billion alternatives business.  You spend a lot of time with our clients, internal investment teams, and thinking about markets more broadly.  What are some of the key themes and insights that are top-of-mind for you at the moment?

Jim Barry:  Thanks, Andrea, and hi, everybody.  I guess private market investors love a good economic downturn, because precedent experience says, you know, the few years afterwards are great vintages for investment.  That's because we see, you know, substantial market restructurings, liquidity constraint, price dislocation, which we look to take advantage of.  And the GFC was no different with phenomenal vintages in the sort of ’09-’10-’11 period for private market asset classes.

But I would caveat that I think this time it’s different and that’s for a number of reasons.  Firstly, I think we have a scale of dry powder available for investment that’s multiples of what was available to investors and managers in late ’08 into ’09 at almost $2.5 trillion. 

Secondly, I think that because of the experience at post-GFC, I think, you know, investors have been kind of waiting for this opportunity, this sort of downturn.  No one expected a pandemic, but certainly I expect investors are and I see are much less gun shy than they were in the period initially post-September ’08.  And that goes to demand. 

So, there’s real demand for assets.  And then, I think the scale of the monetary and fiscal response, which has been referred to many times today, has been just so enormous, I think that sort of immediate flow of opportunity began to dry up as a lot of companies found answers in the liquid markets.  But still, the opportunity is there.

And that brings me to my final point.  I think that GFC had a rising tide lifts all boats in my view, where I think this crisis is different.  And I think we’re going to see much greater dispersion across economies, across sectors, within sectors.  And so, asset selection becomes critical and, you know, and in particular I would say to you, patience in your judgment, as well as discipline, are now critical because the price may look greater than again six months ago, but is it the right price for the risk this asset now faces?  So, back to you.

Andrea Picard:  Okay.  Thinking a little bit just about how client portfolios are structured, and so, Anne-Marie, can you talk a little bit about SWIB’s unique plan structure and where private markets fit in and then how the pandemic has changed your internal conversations around that part of your portfolio?

Anne-Marie Fink:  Yeah.  So, SWIB is a $110 billion plan and we serve more than 640,000 pension participants.  So, and we think about them every day.  Now, what makes our plan different in many ways is the way it’s designed.  So, our pensioners receive a minimum payment every year and then an annual dividend that fluctuates or that’s based on plan performance over the last five years.  So, in part because our liabilities tend to fluctuate with performance, we’re one of the country’s only fully funded plans.

Another advantage of this design for us is that it creates a real direct alignment of interest between our plan participants and our investment staff.  So, as a result, Wisconsin lets staff, the investment professionals, actually make the investment decisions, which means we can tend to pursue more complex and more out of favor strategies and take a true long-term perspective.  And the upshot of that relevant to this panel is that we do have a very meaningful allocation to illiquids.  Specifically, we have about $17 billion in private markets and roughly another $6 billion or so in hedge funds.

Now, to the topic at hand, the impact of the pandemic, I would say at the most basic level it really hasn’t changed anything for us.  Our assets are stable, and our cash flow needs kind of adjust with performance.  So, there’s not a huge outflow that we’re seeing as a result of this. 

And so, what we’re doing is we’re continuing to allocate to private investments and we’re trying to find ways to use our stability and long-term view to find opportunities during this time of great uncertainty.  Though kind of leading off of what Jim said, it’s been, it’s actually been a little surprising how little dislocation there has been for the reasons that he mentioned.

Andrea Picard:  So, Lynn, I think that ties pretty well into what’s happening in the private equity market as well.  One of the things you mentioned to me is that the market isn’t fully pricing in risk and that there’s a real bifurcation in the market right now.  So, can you talk a little bit about what you’re hearing from clients and GPs and what you're seeing in the market?

Lynn Baranski:  Yeah, sure, Andrea.  You know, it’s really hard to believe that it’s been four months since we moved to working from home and since states literally went into lockdown and since we saw the public markets bottom out in March.  I truly believed there was going to be an adjustment period, similar to what we saw post the GFC in private equity where there would be some period of time where the buyers’ and sellers’ expectations on price would need to find some sort of balance and normalcy.  But, as Jim mentioned earlier, you know, we – this is not what we have seen.  Actually, with all the stimulus coming into the economy, we’ve actually seen deals and volumes of deals continue at a higher rate than I would’ve expected, although reduced volumes compared to last year. 

So, since March, I like listening to everyone’s forecast of what the economic recovery would look like.  We’ve gone from a V-shaped recovery to a U-shaped recovery to a Nike swoosh recovery.  We’ve then gone back to a V-shaped recovery and now, and the most recent one I'm hearing is a square root shaped.

So, what this really is telling me is that no one has the perfect crystal ball here.  And what I really worry about is that we aren’t fully building into our forecasts the long-term impact of unemployment, the long-term impact of the operational slowdown that we’ll see at these companies, and that there’s still significant parts of our economy that are really hurting, retail, restaurants, travel, leisure, energy just to name a few.  And then, you compound that by the economic environment with it being an election year. 

So, I think there remains considerable risks in the market that we just need to be aware of and I think Jim spoke really well when it’s like patience is key here in today’s market and taking the time to find those great opportunities.  Now, having said all of that and being a little bit maybe of a pessimist, I would say that private equity is one of the most resilient and adaptable asset classes I think there is.  Having watched this market and private equity for the last 20 years, volatility and market dislocations usually provide a really great backdrop for private equity and history has shown us, as Jim mentioned earlier, that those vintage years following volatility and dislocations tend to be some of the best vintage years.

So, as we’re out talking to our GPs today, they’re really focused on three key areas.  One, they are continuing to invest capital, but they’re investing capital behind strong macro tailwinds and I’ll come back to this in a minute.  And they are very focused on operational improvements inside the portfolios, companies that they already own.  They’re looking to can they grow, how to grow organically, how to take market share, can they grow through M&A, how do they drive operational improvements, are they upgrading management teams? 

So, they’re very internally focused right now on those investments.  And then, they are all focused on building the balance sheets and making sure the balance sheets of their portfolio companies can endure what will certainly be continued uncertain times. 

So, as I spoke to you earlier about sort of the bifurcation in the market and how the market snapped back so quickly, there does seem to be a bit of a bifurcation.  If you look at the technology sector, the late stage venture capital, the growth equity sectors, they clearly are – remain on fire.  The valuations for those businesses continue to be very strong.  Those companies are getting funded at valuations that are in excess of where they were funded six to nine to 12 months ago.  And yet, at the other end of the spectrum we are starting to see increased default rates in the energy, retail, travel, leisure sectors.

So, I will – that’s one – that was my comment around at being slightly bifurcated.  But in general, as I mentioned, the general partners are focused on continuing to deploy capital cautiously in those industries that – where they have the highest conviction.

Andrea Picard:  So, Anne-Marie, is this consistent with what you’re hearing from your private equity GPs?

Anne-Marie Fink:  Yeah.  I would say it’s pretty consistent.  And overall, I’ve also been surprised at actually how little change there’s been.  When we look at the – we’ve seen actually surprisingly little distress among portfolio companies though with that bifurcation that Lynn talked about.  So, energy we’re certainly seeing a fair amount of distress and much less so in other places.  And overall, for the first quarter for the 3/31 marks, we saw valuations fall about a third the level that the public markets fell and we’re actually even seeing some write-ups as we’re going into 2Q, though noting that it’s very early.  So, that’s been a little surprising.

Also, surprising, if I could comment on the fund level, is more established and larger GPs seem to have no trouble raising capital and a number of them are, you know, raising capital right now.  And some even seem to view the current environment as a marketing opportunity, so they’re rushing to raise a dislocation fund, even though they have plenty of dry powder in their current fund, which is a little annoying.  And then, actually I would say the most surprising to me has been that there’s a handful of GPs that we’ve been talking to who are actually changing the terms on their funds to make them actually less LP-friendly, which is an indication of just how much demand there is out there.

We’ve seen one that’s moved from 20% to 25% carry and another that always had premium carry, but they’ve lowered the bar to earn that premium carry.  And actually, when we reach out to our fellow LPs it has sort of concern that people still have a lot of money to put to work, because we haven’t seen much interest in pushing back.  So, that’s been a bit of a surprise to us.  Lynn, what are you guys seeing on that front?

Lynn Baranski:  Yeah.  Absolutely.  It’s definitely the big keep getting bigger and the strong keep getting stronger for sure.  We’re seeing continued consolidation of capital raising into the larger firms and the firms continuing to stratify how they raise capital. 

It used to be, you know, we have mid-market Pan-European firms now that stratify the market across four different levels of early stage – I'm going to exaggerate – like early stage, early, early stage, mid-middle stage, late stage.  But, you know, the GPs are definitely trying to stratify the market, stratify their strategies and I always view it as a way that they can try to have more options on their carried interest and more shots on the goal for fundraising and carry just to be slightly pessimistic.

But certainly, we’ve been participating and making commitments to new general partners, not new general, to our general partners over the last five months and those that have, you know, longer track records, more established track records sort of generally perform through good times and bad.  It is very easy for them to raise capital right now and there’s very little ability to influence terms, as you mentioned.  It’s definitely a GP market right now for those who have a good track record.

I think that we’ll see it more difficult for new funds to raise capital, you know, brand new emerging managers coming out.  We are seeing opportunities ourselves alongside private equity professionals more from a … sponsor standpoint where we can make – coinvest alongside of them and they’re finding it a little bit more difficult to raise capital.  But, for those established managers it is quite easy and they – and, you know, they provide the terms that they expect people to take.

Andrea Picard:  So, this is a good time to pivot over to opportunities.  So, thanks everyone for responding to our polling question of where do you see the biggest opportunity in private markets today?  So, so far it looks like PE is the favorite with 32% of respondents.  Infrastructure and private credit pretty closely tied, 28% and 27% respectively.  And then 13% of respondents said that they saw the biggest opportunity in real estate.

Okay, Jim, so let’s turn it back to you.  As someone with a view into BlackRock’s entire alternatives platform, where are you seeing opportunities in the private markets?  And has client demand reflected that opportunity set?  Are you seeing this, you know, more client demand that Lynn and Anne-Marie spoke about?

Jim Barry:  So, yes, Andrea, we are.  And actually, I think the audience have captured it fairly accurately.  I think there’s general opportunity in private markets with real estate maybe being the outlier, because if you think about the structural shifts on the way, huge amount, that goes to the utility and productivity of space, whether in the office or whether at home, and how we locate that space.  And so, I think it just carries more risk and so I would say to you just more general bias towards quality at the moment in real estate.

With respect to the others, I mean just private equity has been touched on.  But we do like credit an awful lot.  I mean everybody’s focused on liquidity and we are seeing consistent flow of opportunity.  I think it would’ve been greater if we hadn't had the monetary and – or the liquidity response of policymakers.  But it’s consistent and we’re seeing a premium over rates in the private credit space as against pre-crisis. 

I love infrastructure debt.  Its capital attachment point makes it very attractive, even in the more challenged transport sector, and we’re seeing a consistent premium over prior crisis pricing.  Also, in infrastructure, we like playing into just the energy transition on the way, which is very fundamental.  We didn’t touch on the fact that energy has to deal with a supply dislocation because the pandemic wasn’t bad enough.  And so, you know, that’s created stresses which on the back of it for strong companies there’s opportunity to invest as they look at liquidity.  And then, we’re just seeing the consistent transition to renewables, decarbonization, which brings consistent investment opportunity.

Another area we like is secondaries.  I think that whole continuum of liquidity between the classic bonds and stocks as against the private market is beginning to blur and certainly the increased liquidity of stakes in GP fund, you know, kind of is driving a new set of opportunities.  And I think in particular, as I think we’ll begin to see LPs reallocate and, you know, either increase or dispose of positions, you know, this is going to throw opportunities for secondaries as well.

And then finally, I would say to you I'd like to put some capital away for the credit dislocations that I think there’s still a very good chance of coming.

Andrea Picard:  So, Anne-Marie, before we pivot to you, Jim, I want to stay with you for a second just to go back to this idea of globalization.  So, we’ve been talking about that a lot today in many of the sessions.  And just thinking about, you know, you’re looking at global private markets.  Are you concerned at all or have any thoughts about, you know, kind of a changing picture from a globalization standpoint and how that might affect opportunities?

Jim Barry:  So, globalization or the evolution of it as Kate and Larry were talking about earlier today, I think is something that’s very real for a private market investor.  And I think what it really is an acceleration of effectively a trend that had begun on the back of geopolitical tension.  And I think you’re going to see it particularly play out in certain sectors, technology, medics, medical industries, etcetera. 

And so, wherever you look, whether it’s companies facing increased costs, facing increased in terms of both relocating and restructuring supply chains but also more inventory, a case of no longer just in time, now just in case, with respect to resilience, then the flows and what that might mean for infrastructure and real estate, so with cuts across the board.  And so, back to this issue about dispersion, I think that the real challenge is risks have changed and one has to be very cognizant of it and very disciplined in assessing them and then patient about where you jump, because as I said earlier, the price may look great as against six months ago.  Is it the right price for the risks that business now faces?

Andrea Picard:  Right.  That makes sense.  So, Anne-Marie, pivoting back to you, what is SWIB focused on right now?  I mean, where are you seeing the most value-added opportunities and, you know, have you tried to make any, you know, changes in the portfolio specifically or anything that you’re looking for?

Anne-Marie Fink:  Yeah.  So, I’ll comment on three areas and in general they’re not vastly different from what Lynn and Jim have been talking about.  In private equity, we are actually seeing some opportunities in small and micro funds who are the one place that are having trouble raising funds, partly because no one’s traveling so it’s hard to get to know these up-and-coming fund managers. 

So, we’ve been – we’ve in a few occasions kind of stepped in and become anchor investors for these teams that we have high conviction in.  And we really like it because, one, we actually are getting somewhat better economics in exchange for taking that anchor position.  They – we also think there’s more inefficiencies in pricing and on the buy if you will at the smaller end of the market.  And also, you know, these managers tend to be a little bit more hungry, and so, we also think there’s better alignment between us and the GPs.  So, that’s one area that we’re working on.

It – the second area is in real estate and kind of consistent with what Jim talked about.  We’ve been allocating a fair amount to get managers within the real estate sector.  So, and particularly managers that kind of tend to invest in fulcrum securities and have experience in workouts.  So, we really like being kind of in the middle of the capital stack where, you know, we’ll get solid returns if the world returns to normal and we have the potential for extraordinary returns if we do have the distress like that some of us have been kind of anticipating that hasn’t really shown up yet.

And then thirdly I’ll mention the place that we’re not committing capital to at the moment is a lot of these distress funds that are being raised.  And basically, the way we’re thinking about it is that if it’s that easy to raise distress money, you're not going to have a proper distress cycle.  So, we are maintaining our typical allocation to distress.  We’re just not kind of trying to step up with it.  At the same time, though, I will say we are staying very close to our managers and we’re reminding them of the stability of our capital and our ability to move quickly.

And so, we’ve been able as a result of that to upsize some investments in some capacity constrained PE managers on the smaller side and then actually also in some capacity constrained hedge funds where we were able to write checks pretty quickly.  And then, we’re also kind of reminding our GPs that we have the full ability to purchase secondary LP stakes and that we have a well-developed coinvest capability.  So, to the extent as I personally, I won’t speak overall SWIB, but as I personally expect that we’re kind of at the beginning of this cycle and we haven’t seen the full impacts yet, and so we just want to be kind of patient, as Jim mentioned, and be prepared if the – if this cycle evolves to more distress than we’ve seen so far.

 Andrea Picard:  So, interestingly enough, we had one question come in from one of the – from a member of the audience that talked about dislocations and it said what – and the question was what events do you think will cause them?  So, Anne-Marie, if you have anything that you’re looking for specifically that you think might trigger some of these real big dislocations, love to hear that.  And then, Jim, I'm going to pivot back over to you to see if you have a response to that.

Anne-Marie Fink:  Yeah.  I, I'm not sure what’s going to trigger it.  I mean the one thing that certainly we are watching very closely is kind of what’s going on in Washington, both with the election later this year and then also as I believe Jim mentioned, part of the reason that we haven’t seen as much of the distress as we might’ve anticipated was there’s been such an enormous both fiscal and monetary response.  And we're sort of watching carefully to see how long that response continues or if we start to see some fiscal fatigue, because that we think could be another catalyst to kind of drive things in a different direction than what we’re seeing today.

Andrea Picard:  Thanks.  That makes sense.  Okay.  So, Jim, we’re coming up on time, but we’ll close with you.  From a platform standpoint, what are you most excited about for the remainder of 2020 and then going into 2021?

Jim Barry:  Well I, I'm not sure excited is the word I would use, Andrea, in the sense that I'm very wary.  I'm getting very comfortable as the resident bear in BlackRock and debating with my don’t fight the Fed colleagues about what’s going on.  I think that the real challenge is there’s real economic damage being done by the economic consequences of the pandemic.  And there's no question, you know, this fiscal and monetary response has inoculated the market certainly from the worst of that and clearly the fiscal intervention has helped companies and people, keep them in employment.

But, it’s beginning to wear through now and I think that combined with challenges of managing the pandemic, which is still a huge issue, some of the most significant economies in the world, not least the United States, have not got this under control.  And so, you know, the question is how does this play out?  And I think that’s what I'm watching more than anything else.  Big focus on originations leveraging the full BlackRock platform or capital markets capability to access anything that’s moving, being very patient and disciplined in deploying, but certainly staying very close to the real economy with a view to being there when sponsors we know, companies we know need liquidity.  And my bias is that as we get into Q4 and turn of the year, we’ll begin to see a lot more opportunity flow.  And Anne-Marie may even be allocating some of that extra capital to special situations and credit.  So, with that, I’ll hand it back to you, Andrea.

Andrea Picard:  Well, thank you very much.  I can’t believe that we are out of time already.  This has been super-interesting and I'm sure we could spend another 30 minutes together easily on this topic.  There are a lot of – a lot for our clients to be thinking about as it relates to their private market allocations. 

I'd like to thank our panelists today.  And Anne-Marie, I'm looking forward to seeing you in Madison sometime soon.  A special shout-out and thanks to all the participants who responded to our polling question.  One more will appear on your screen as we conclude.  Please let us know if you would like a member of the BlackRock team to follow-up with you on any of the topics we discussed today. 

 Have a great afternoon and we look forward to seeing you tomorrow, day two at noon Eastern, for our first session hosted by BlackRock’s Chief Investment Strategist Mike Pyle and featuring former Treasury Secretary Larry Summers and BlackRock’s CIO for Global Fixed Income, Rick Rieder. Thanks again.