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Private capital: The quest for quality
Investors are increasingly turning to private capital for stability in the face of public market volatility, recession fears and banking sector turmoil. Private capital not only provides attractive income and return potential, but also serves as a portfolio diversifier, generally with lower mark-to-market volatility than public markets. However, it is critical to align with experienced managers that remain vigilant, selective and diversified.
Top reasons we make deals
Companies within our portfolio are expanding
In volatile markets, the healthiest companies often seek to grow through M&A. Private capital managers with large portfolios and flexible mandates may be well-positioned to benefit. For example, at Nuveen’s private credit specialist, Churchill Asset Management, through Q1 2023, financing add-ons within the existing portfolio represented 60% of senior lending volume and 20% of the capital deployed by its equity co-investment strategy. Add-on transactions represented more than 70% of all U.S. middle market private equity deal count in 2022, and we expect those tailwinds to continue.1
We capitalize on top-tier sponsor relationships
In today’s environment, top-tier private equity firms with strong investment teams; proven value creation strategies; and differentiated networks of partners and executives have the ability to perform regardless of broader economic conditions. Further, working with top-tier sponsors can give investors a wide perspective on deal flow, driving increased selectivity. The ability to identify and access private equity firms with which to partner is predicated upon years of relationship building, cemented by scale and a longstanding market presence.
We seek opportunities that are less cycle sensitive
What does it mean to be non-cyclical in today’s world? Nuveen’s private capital team seeks to identify businesses whose products and services are 1) non-discretionary, 2) purchased on a recurring basis and 3) comprise a small percentage of customers’ overall cost structure but command a high cost of failure. In our experience, companies that demonstrate these three factors are most likely to reduce downside risk in a variety of market conditions.
Top reasons we turn down deals
Companies lack sustained free cash flow
Companies are now subject to greater cash outflows due to higher interest rate burdens. Like-for-like leverage has declined for companies seeking to adequately cover their increased all-in borrowing costs. Sustainable earnings will play an even greater role than interest rates in influencing a company’s ability to service debt. Lastly, we are scrutinizing aggressive capex plans to see how quickly capex spend converts to revenue, as well as a company’s ability to shut off expenditures in a downside scenario.
Equity alignment is insufficient
Greater equity alignment between private equity sponsors and management teams typically provides lenders and co-investors comfort that sponsor partner support will continue through business-specific or macroeconomic headwinds. We have even found that a greater equity contribution (from sponsors and management) at deal origination directly correlates to the level of support provided in times of distress. Additionally, a cash equity investment provides a true market valuation and loan-to-value for a particular asset, as opposed to calculating an implied enterprise value.
ESG elements are not suitably incorporated
The influx of capital into the asset class has enabled constituents to apply an Environmental, Social and Governance (ESG) lens to high-risk business models, as well as identifying businesses that can make positive societal changes. Our ESG due diligence framework is an important tool to help find businesses on the front foot of the ESG spectrum, supplemented by private equity partners seeking innovation to encourage more sustainable practices, that are better positioned to navigate a changing market landscape.
In this issue
1 Pitchbook 2022 Annual U.S. PE Middle Market Report.
The views and opinions expressed are for informational and educational purposes only as of the date of production/writing and may change without notice at any time based on numerous factors, such as market or other conditions, legal and regulatory developments, additional risks and uncertainties and may not come to pass. This material may contain “forward-looking” information that is not purely historical in nature.
Such information may include, among other things, projections, forecasts, estimates of market returns, and proposed or expected portfolio composition. Any changes to assumptions that may have been made in preparing this material could have a material impact on the information presented herein by way of example. Performance data shown represents past performance and does not predict or guarantee future results. Investing involves risk; principal loss is possible.
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Important information on risk
All investments carry a certain degree of risk and there is no assurance that an investment will provide positive performance over any period of time. Equity investing involves risk. Investments are also subject to political, currency and regulatory risks. Diversification is a technique to help reduce risk. There is no guarantee that diversification will protect against a loss of income. Debt or fixed income securities are subject to market risk, credit risk, interest rate risk, call risk, derivatives risk, dollar roll transaction risk, and income risk. As interest rates rise, bond prices fall. Foreign investments involve additional risks, including currency fluctuation, political and economic instability, lack of liquidity, and differing legal and accounting standards. These risks are magnified in emerging markets.
As an asset class, real assets are less developed, more illiquid, and less transparent compared to traditional asset classes. Investments will be subject to risks generally associated with the ownership of real estate-related assets and foreign investing, including changes in economic conditions, currency values, environmental risks, the cost of and ability to obtain insurance, and risks related to leasing of properties. Real estate investments are subject to various risks, including fluctuations in property values, higher expenses or lower income than expected, and potential environmental problems and liability. Please consider all risks carefully prior to investing in any particular strategy. A portfolio’s concentration in the real estate sector makes it subject to greater risk and volatility than other portfolios that are more diversified and its value may be substantially affected by economic events in the real estate industry. International investing involves risks, including risks related to foreign currency, limited liquidity particularly where the underlying asset comprises real estate, less government regulation in some jurisdictions, and the possibility of substantial volatility due to adverse political, economic or other developments. As an asset class, agricultural investments are less developed, more illiquid, and less transparent compared to traditional asset classes. Agricultural investments will be subject to risks generally associated with the ownership of real estate-related assets, including changes in economic conditions, environmental risks, the cost of and ability to obtain insurance, and risks related to leasing of properties.
Investors should be aware that alternative investments including private equity and private debt are speculative, subject to substantial risks including the risks associated with limited liquidity, the use of leverage, short sales and concentrated investments and may involve complex tax structures and investment strategies. Alternative investments may be illiquid, there may be no liquid secondary market or ready purchasers for such securities, they may not be required to provide periodic pricing or valuation information to investors, there may be delays in distributing tax information to investors, they are not subject to the same regulatory requirements as other types of pooled investment vehicles, and they may be subject to high fees and expenses, which will reduce profits. Alternative investments are not appropriate for all investors and should not constitute an entire investment program. Investors may lose all or substantially all of the capital invested. The historical returns achieved by alternative asset vehicles is not a prediction of future performance or a guarantee of future results, and there can be no assurance that comparable returns will be achieved by any strategy.
Responsible investing incorporates Environmental Social Governance (ESG) factors that may affect exposure to issuers, sectors, industries, limiting the type and number of investment opportunities available, which could result in excluding investments that perform well. ESG integration incorporates financially relevant ESG factors into investment research in support of portfolio management for actively managed strategies. Financial relevancy of ESG factors varies by asset class and investment strategy. Applicability of ESG factors may differ across investment strategies. ESG factors are among many factors considered in evaluating an investment decision, and unless otherwise stated in the relevant offering memorandum or prospectus, do not alter the investment guidelines, strategy or objectives.
Nuveen, LLC provides investment services through its investment specialists.
This information does not constitute investment research as defined under MiFID.