Inflation’s Impact on the Global Market Ecosystem

It’s no secret that inflation’s impact on the economy has spilled over to the alternative investment industry, despite an optimistic investor outlook entering 2022. EisnerAmper’s 7th Annual Alternative Invest Summit, titled Raising the Curtain: The Next Act for Alternative Investments addressed this timely topic during a virtual panel discussion called “Inflation’s Impact on the Global Market Ecosystem.” Speakers explored the impact of inflation on the economy; the outlook and deal pipeline for alternative investment managers; and the challenges, risks and opportunities in this market cycle.

Panelists included:

• Lisa Shalett, chief investment officer and head of the Global Investment Office, Morgan Stanley Wealth Management;
• Christopher W. Kersey, founding managing partner, Havencrest Capital Management; and
• Gautham Deshpande, partner, EisnerAmper (moderator)

Here were a few themes discussed:

Inflation’s Impact on Hedge Fund Managers:

The panel discussed three ways inflations will impact hedge funds in the near term. 

• Higher inflation leads to higher nominal interest rates which decreases multiples on risk related assets and leads to the need to recalibrate the valuation framework.
• Fund managers need to differentiate between volume driven operating leverage and pricing power when picking stocks since pricing power can be volatile during periods of inflation and operating leverage is the true volume related growth.
• Finally, portfolio managers should revisit the role of real assets in a portfolio which inherently have inflation protection built in including those linked to infrastructure, real estate and capital-intensive areas of the economy.

Inflation’s Impact on Private Equity Fund Managers

Inflation also effects private equity fund managers in the following ways:

• Exit activities will slow down and it’s crucial fund managers be patient and wait for favorable exit opportunities.
• An increase in interest rates will decrease portfolio company valuations.
• Holding periods will lengthen, hence both general partner (GPs) and limited partners (LPs) will need to have patience to obtain the most value from an investment.

Next Steps by Private Equity Fund Managers

In the current environment, managers are encouraged to focus on a few key things including “real operational value-add and not just financial reengineering value-add,” thematic investing and for public companies to focus on both their core and non-core business. The non-core business focus will lead to other investment opportunities including taking private opportunities or PIPE opportunities.  Finally, GPs should shift their investment criteria to investing in companies that have greater pricing power, greater margin protection, limited exposure to government reimbursements, and limited exposure to geopolitical risk, as well as those that aren’t affected by discretionary spending or risk of government shutdowns. 

How Are Private Equity Managers Adjusting their Portfolios?

Private equity managers are adjusting their portfolios to ensure they deliver risk-adjusted returns to investors in the following ways:

• Shoring up their balance sheet and using cash strategically;
• Reviewing inorganic growth strategies since organic growth strategies are slowing down;
• Infusing technology into service platforms since the revenue model is optimized and will potentially raise the exit price; and
• Buying investments at the right time by not paying too high of a price.

How Is Inflation Impacting Portfolio Companies?

Wage inflation is squeezing margins at service companies.  To combat wage inflation, successful companies are highlighting their mission and culture to attract and retain employees.  Raw material inflation is impacting product companies.  To combat this, companies are reengineering their product lines and implementing cost-pass-through strategies to their customers.

What Parts of the Market Offer Relative Value or Opportunities?

There are opportunities to find fairly valued defensive growth investments at reasonable prices.  One sector where opportunities are available is the health care sector.  Value or cyclical-oriented opportunities will perform better and companies that embrace operational excellence, technology and automation will tend to perform better and will create upside opportunities.  Other industries that present opportunities for returns are financial services, energy and consumer services industries. 

To view the panel, click here.