Trends Watch: Beta; Niche Investors
- Sep 26, 2019
EisnerAmper’s Trends Watch is a weekly entry to our Alternative Investments Intelligence blog, featuring the views and insights of executives from alternative investment firms. If you’re interested in being featured, please contact Elana Margulies-Snyderman.
This week, Elana talks with Andrew Cohan, Managing Member, Halmos Capital Partners.
What is your outlook for private equity?
I tend to think about private equity in two general buckets. While this is an over-simplification, there is private equity beta and then there are value-add niche investors. With the increase in the size and number of private equity funds in existence, many of them mimic a sort of private version of a mutual fund. They create diversified portfolios of companies, and then hold them for a period of two-to-seven years. The typical fund structure does not allow for long-term holding periods. Given the sheer size of these funds, the vast majority of these investments are purchased in auctions, and thus fully priced. I believe the returns of these funds should generally follow those of a levered portfolio of similarly sized companies in a public market index (e.g., the Russell 1000), or whatever relevant benchmark exists for their areas of focus. The "value-add niche" players come in all sorts of shapes and sizes. Some have industry expertise in differentiated sub-sectors that face less competition. Others have robust operational expertise. The results in this sector should be less correlated with the broader market, and will differ widely based on the skill and area of focus of the investors. Targeting specific niches and then adding operational value on an ongoing basis throughout the life of each investment should generate outsized, uncorrelated returns.
What opportunities and challenges do you see in lower middle market investments?
Keeping with the theme above, I think there is opportunity for private equity investors to focus funds on specific niches. For example, wastewater in the energy space driven by the increase in fracking (a water intensive process that is the main source of oil and gas development in the U.S. today) presents an attractive opportunity, if approached carefully. Fracking has transformed the U.S. from a declining producer of oil and gas to the largest producer of both commodities worldwide. This inflection in production has provided a major boost for our economy, and the trend of growth will continue for years to come. A byproduct of this technique is wastewater, both from the fracking process itself as well as water that is naturally mixed in with the oil and gas below ground. Mom-and-pop water disposal companies previously served this industry, but with the recent growth there has been a need for professionalization of these businesses. Thus, returns can be generated by buying small companies at the right valuation, picking the right areas that will see increased drilling activity, and building to serve the growth within the market. There is also an opportunity to move more water via pipe under hard contracts, as opposed to by truck on the spot market. All of these factors create an environment where a focused private equity investor can put the pieces together and drive value using multiple levers.
More generally, I see an enormous opportunity to help the aging baby boomer generation find a solution for the businesses they founded. They want a monetization event coupled with an ability to stay involved in seeing the business transition to a point where it can sustain and grow without them. Traditional private equity is not always the best exit option for these owners.
What keeps you up at night?
At Halmos we are more dependent on driving value via operations and changes at our portfolio companies than we are on macro factors. Therefore, idiosyncratic challenges as we grow and manage our companies are a natural part of the value creation process and tend to take more of my mindshare than broad market conditions.
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Elana Margulies-Snyderman is an investment industry reporter and writer who develops articles, opinion pieces and original research designed to help illuminate the most challenging issues confronting fund managers and executives.
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