Private markets are not immune to the challenges of an uncertain economic environment and rising rates.
For Greg Olafson, co-president of alternative investments at Goldman Sachs Asset Management, or GSAM, the uncertainty — which has led to a significant drop in private equity deals this year, according to London-based data provider Preqin — requires a back-to-basics approach to private equity and a look at private credit.
The back-to-basics approach means acquiring the right companies and owning them well, Olafson says.
“That’s what private equity is — it’s direct influence over what you own,” he says. “You buy a company and you help the management team improve the company, grow the company, and you do that through your experience, through your team’s [experience] and bringing your resources to bear.”
At GSAM, those resources are extensive. Olafson recalls a meeting over the summer to consider an investment in Mexico. As the merits of the deal were appraised, the alternatives investment team brought in its Mexican peso trader, its country adviser, an investment banking adviser, and other experts. “We aren’t calling an adviser, we’re calling a colleague,” Olafson says.
Penta recently spoke with Olafson about navigating private markets as an investor, and as an owner of private companies, now that economic conditions are tougher.
Leaning into private credit
Providing debt financing to companies in the private markets has boomed in recent years to reach $1.2tn as of the end of last year from less than $500m a decade earlier, according to Preqin. That includes funds involved in direct lending, distressed debt, and higher risk special situations and mezzanine debt.
Together, the category is the fastest-growing among alternative investments, the firm said in a recent report, The Future of Alternatives in 2027. By 2027, Preqin forecasts assets in private debt funds will total $2.3tn.
Amid rising rates, investing in private credit has proved to be “a good place to hide,” Olafson says. “You can get paid double-digit yields, cash-on-cash, for lending to great companies.” They also lend to private equity firms, which will borrow from private credit lenders to help finance the companies they buy.
The key, Olalfson says, is to finance good companies and to do so with strong underwriting. Providing financing today, even to the best of companies, is leading to significantly higher returns because of the uncertain economic environment, he says. A deal that may have been financed for 5% or 5.5% before will get done for 6% or 6.5% today, for example, he says. “It’s 25%, 30% more return for a given risk.”
GSAM is less interested now in financing companies in distress. Although he started his career working in distressed debt, Olafson says he would invest in the sector now only if the conditions were right.
There are two main triggers that could provide the conditions: “If you have a wholesale issue that causes dislocation in an ownership base, which basically leads to forced selling, or you have so much uncertainty [a fund] doesn’t want to continue to own what they own and they capitulate,” he says.
He adds, “we’re not there in the credit world yet.” But that could change if the Fed keeps raising rates. Already, some borrowers that were paying interest rates of about 8% are paying double-digit rates now, a level most can’t sustain for long.
Some market observers have raised concerns about private-credit markets in recent months, because of the dangers of rising rates. Many private-credit funds, such as those offered by GSAM, are based on floating-rate loans. If rates keep rising, companies will have to pay more, and some could run into trouble keeping up.
Creating value in private equity
Through the second quarter, the global aggregate value of private equity deals fell by 44% from a year earlier to $131bn, while the number of deals also fell, Preqin reported. (Third-quarter data hasn’t been released yet).
The biggest shock to the private equity world has been in growth funds, which were largely investing in technology. These companies went from the best of times, “to a very challenging environment very quickly,” Olafson says. “They needed to very quickly turn from a mindset that was growth…to managing for cash.”
Olafson says GSAM brought in its investment and operating teams to these companies to help them respond.
“The byword in the private equity business is ‘back to basics, focus on value creation, and help [companies] navigate very uncertain times’,” he says.
GSAM recently closed a $9.7bn private equity fund known as West Street Capital Partners VIII. According to a September news release, the fund targets upper mid-market companies, investing $300m in each on average. To ensure the success of its portfolio, the companies have access to the “GS Value Accelerator,” which is a network of 80 professionals, including CEOs and other managers, who can assist companies with their financial strategies, digital transformation, ESG requirements, and risk management, among other things.
“We think the private equity ownership model is a winning model,” Olafson says. “But it’s more than financial engineering, momentum, and cheap money. It’s back to value-creation basics.”
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