This interview, part of Clear Path Analysis’ series of one-to-one discussions with leading North American based asset allocators, economists and politicians, focuses on the factors external to private markets that are affecting prices in the sector. Issues covered include, what are some of the private asset classes that you currently have exposure to, how has energy been treating you, with oil at all-time lows, has the increased shift towards renewable energy sources changed views of the sector, if private equity and private debt are overvalued, segmentation of private equity by industry, plus if investors might consider changing their approach to public and private markets.
David Grana: What are some of the private asset classes that you currently have exposure to?
Elizabeth Jourdan: We are very diversified and have allocations to private equity, private debt, private energy and private real estate.
David: How has energy been treating you, with oil at all time lows?
Elizabeth:Mercy’s private portfolio is fairly new and has only been in the ground for a few years. A lot of our private energy exposure is 2012-2014 vintages. Because of the recent increase in oil prices from the lows of 2014-2015, we have seen a lot of appreciation in private energy assets. As a result, these investments have been treating us fairly up until this point. For a while, it didn’t look very good, but we are pleased to see a healthy rebound in private energy.We are relatively new to this sector and continue to make allocations of one to two funds per year. Given the lower dollar price of oil, we would tend to be overweight in this sector, since we feel that there is opportunity. That being said, we don’t try to significantly time vintage years, and it is hard to do when we only make one to two allocations per year.
David: Has the increased shift towards renewable energy sources changed your view of that sector?
Elizabeth:Mercy has a socially responsible investment policy that we rewrote in late 2016. Stewarding the earths’ resources is one of our critical concerns. Renewable energy is an area that we have interest in and, while we haven’t made any allocations there, we are very intellectually interested in the shift towards renewable energy sources. We don’t have a very hard lined view on the sector, but it is a place that we think warrants more diligence and time.
David: Does it at all feel like private equity and private debt are overvalued and that the segment has overheated?
Elizabeth:It is hard to look at the metrics in both private equity and private debt and not say that things are at overvalued.The way that we are coping with this is that we are trying to shift downmarket into smaller cap focused or sector funds where we have a little more clarity in the returns coming from actual operational efficiencies and value-add, rather than financial leverage. Particularly in the changing IPO market, where you are seeing less private companies go public, we want to make sure we have visibility into how exits occur.
With private debt, we have historically been skeptical of the potential future returns in areas like traditional middle-market direct lending, given the timing of market cycle, a wide number of direct lending managers without recession experience, and tighter pricing as demand has increased. And over the past few years, you have seen convenants loosen and spreads tighten, given the popularity of direct lending. Since Mercy is a smaller institution, we are able to be nimble and avoid this part of the credit market altogether. In private debt, we have been looking at more niche strategies in small balance commercial loans and other parts of the specialty finance markets where we think there is more relative value and perhaps more exposure to the consumer than corporations.
David: Do you segment private equity by industry as you do with some of the other asset classes where you look at various different sectors?
Elizabeth:We group our private equity by venture and buyout. We don’t necessarily do it by industry, but we are open to doing sector focused funds.
David: Do you see any sectors or verticals that are particularly interesting where you have seen that they haven’t overheated?
Elizabeth:We have been doing more healthcare and life sciences funds because it is a natural fit for Mercy, as a hospital system. We can see the value in a lot of the growth equity-type of investments that these firms are investing in. With life sciences, we see parts of the pharmaceutical market where consumer needs are not being met and financing is more difficult. In addition, this is an important component of our socially responsible investment policy, with a critical concern of advancing quality healthcare. We find this to be an area where the value proposition still exists, hence why we have been allocating to it. With so many changes in the healthcare market nationally, there seems to be a lot of moving parts that will create winners and losers in this industry and we want to align ourselves to hopefully be part of the change that helps consumers, increases quality and drives down costs.
David: What do you feel will be the impact of Amazon and other online retailers on commercial real estate?
Elizabeth:We think a lot about how technology will impact all parts of our portfolio - not just commercial real estate. One issue that we have heard a lot of our commercial real estate managers discuss is the shift from the traditional, regional mall to more experienced-based retail and that is where they are focusing a lot of their time and energy. These could be strip malls that have stores like Homegoods, or those with eating establishments. Online retailers have driven the consumer to the internet by making it so easy to get what you want and quickly. This will continue to have an impact on how consumers shop and, as a result, on where there is value in the commercial real estate market. On a different front, technology has also deflated pricing within certain components of CPI, and we continue to assess the implications that has on future economic growth
David: How do you think investors might consider changing their approach to public and private markets, respectively?
Elizabeth:I would have to reiterate the idea that thinking about how your private equity fund is going to exit its investments is something that the LP needs to be more cognizant of these days. We have seen the IPO market shrink significantly. I would also keep an eye on the amount of financial leverage that companies are using to produce returns, particularly as interest rates begin to increase.
David: Thank you for sharing your thoughts on this topic.