Our world is changing and in response, risk vs. return themes and profiles are also registering substantial shitfs. It is important to know exactly what these new themes are.
Current relevant RISK theme:
Credit Risk. Before the financial crisis hit, there were a large grouping of companies that relied on a steady flow of credit from banks to feed their OPEX in order to grow. These companies have always had good management and their markets were showing healthy signs of steady growth. Many private equity firms did not see much risk in their way of operation (or at the very least they did not put much weight on the potential risk these companies posed).
The risk profiles of these companies has changed dramatically. Without adequate credit, many of these firms have been forced to liquidate large portions of their operations. Within a single quarter, we saw these companies go from healthy to distressed due to a lack of OPEX capital.
Current relevant RETURN theme:
Stability. The primary return expectations have also changed dramatically over the past six months. Private equity and venture capital firms have consistently performed under par of what they originally promised to their limited partners. Expectations of grand returns during a severe downturn in overall global valuations is unrealistic and therefore most LP’s have opted for stability rather than growth.
At least for the time being, I believe LP’s are more concerned with ‘safety’ rather than ‘aggressive growth’. The problem here is that a private equity firm is not designed for ‘safety’ but rather tends to concentrate on aggressive risk taking.
In the new and transformed investment world of today, I believe private equity firms must be able to shift their focus rapidly between aggressive growth and stability as LP’s are now demanding more rights and flexibility from GP’s.
It will be very interesting to see the sea of change that is up against the private equity and venture capital worlds.
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