An interview with the Managing Director of J.P. Morgan Asset Management's Private Equity division.
How have private equity allocations shifted between Q1 and Q3 this year?
They haven’t really shifted materially. At the end of Q1, our focus was on our existing portfolio, especially on the direct investment side – providing capital to existing investments that were strong and would prosper after COVID-19. With a few exceptions, our direct portfolio did not need additional capital and has held up quite well.
Today, we’re engaging in the same opportunistic approach that we always have: funding GPs [general partners] focused on early-stage VC and growth investments, and corporate finance in the shape of mid-market buyouts in the US, Europe and Asia. We pursue primary (and partially funded) partnership investments, co-investments, secondaries, and direct growth investments.
How can private equity investments be optimized at a time of crisis-level low growth?
I don’t think much has changed in terms of optimizing our strategies. The one thing that has evolved is that we’ve seen an increase in growth-oriented investments across all of our focus geographies, where a company can grow top and bottom lines in excess of 20% even in geographic regions with slower growth because they are taking advantage of either newly created markets or fast-growing niches. We have pursued and will continue to pursue such opportunities, many of which are in the tech-enabled services sector. Groups that used to do traditional buyouts, as well as growth capital firms, are now taking advantage of this market in the US and Europe.
Whether we’re in a period of high or low macroeconomic growth, we try to time-diversify our clients’ portfolios across investment cycles, with different lengths of investment.
Private equity firms that specialize by sector tend to enjoy higher returns. How does J.P. Morgan Asset Management approach and foster specialization?
Our objective is to find the best private equity firms and take advantage of the best investment opportunities for our clients. Many firms that we back, especially but not only in VC, specialize in IT or life sciences. Even on the buyout side, most of the firms we deal with use sector knowledge or proprietary relationships that give them a competitive edge.
We’ve been investing in private equity for 40 years, more than half of which has been at J.P. Morgan. That history has allowed us to initiate and manage long-term relationships with other private equity firms, many of which have generated strong performance across multiple market cycles. We supplement those with newer opportunities. It’s such a people business: the principals at the private equity firms use their human capital to get a competitive edge. They find the best managers and CEOs to get those returns.
A recent report by Bain & Company argued that the IRR of public stocks matching or outperforming private equity investments is an American phenomenon; in Europe, PE still performs better. Why do you think this might be?
US public equity markets have outperformed European ones over the last ten years, so there’s a higher bar for private equity to clear. Much of this is driven by the FANMAG [Facebook, Apple, Netflix, Microsoft, Amazon and Google] stocks, which have provided twice as much growth than the rest of the entire S&P 500. So they’ve been responsible for a disproportionate level of growth in the public equity markets. This doesn’t happen in Europe to the same extent – even Spotify, for example, listed in the US.
Of course, the alternative explanation is that the European PE markets are more inefficient than the US, and because of that it is easier to generate alpha. Personally, I believe that a carefully selected portfolio of investments in both the US and Europe can generate alpha relative to the public indices, due in part to the performance dispersion inherent in private equity.
In terms of fundraising, both the US and Europe have upped their fundraising in the last few years. PE has become a key component of many asset managers’ portfolios. Most company sales and financing rounds are priced relatively efficiently, despite pockets of inefficiency. The sector is probably more efficient than it was 10 years ago.
How has J.P. Morgan Asset Management been innovating?
We were one of the first PE managers to create an in-house team to help investors manage equity distributions that they receive from their PE funds. When a PE fund realizes an investment, they can distribute capital two ways: return cash to the limited partners, or – when they exit through an IPO – distribute shares to the limited partners. This happens more with VC but also with some buyout firms. The LPs then have to decide whether to “hold” or “sell” the shares. If managed poorly, the value of the shares can decline, reducing the overall value of an LP’s investment in the corresponding fund.
Most limited partners aren’t set up to make those decisions. Our team makes that “hold” or “sell” decision for a client with the objective of minimizing losses, particularly when shares come off of a lock-up period post-IPO and are subject to selling pressure. This is part of the service that we offer our clients, but this team also provides distribution management services for institutions who manage their own PE portfolios.
We also create relationships with emerging managers – who have only raised their first, second or third funds – to build private equity portfolios in specific geographies. So if the client wants exposure to certain parts of the US or Europe, we’ve done local mandates with clients to deliver the exposure they desire. Sometimes, clients who don’t have exposure to brand-name managers want to find the next generation of those types of managers. Some of them will have a specific desire to focus on managers who are strong on D&I [diversity and inclusion] or ESG [environmental, social and governance considerations], so we help clients with mandates that emphasize that kind of manager selection.
In concrete terms, what has J.P. Morgan Asset Management been doing to ensure strong performance in ESG criteria?
Our private equity team’s standard investment process includes due diligence on sustainability, a written investment memorandum and ongoing discussions with the portfolio managers of the PEG [private equity group] with respect to sustainability issues.
This process includes clarification and assessment of material environmental, social and governance risk factors. When investing in a third-party manager, the PEG encourages the underlying third-party managers with which it invests to carefully consider these factors in their own investment due diligence. Sustainability considerations are an important component of both the initial due diligence and screening process and the ongoing monitoring of investments.
The investment strategy at the foundation of the PEG has been developed and refined over 40 years and through a wide range of market and investment environments. Consistent with our ultimate objective of providing attractive, risk-adjusted returns, specific companies and investment managers, or types of companies and managers, are not excluded from client portfolios solely on the basis of ESG criteria.
However, PEG views issues related to sustainability as important factors that are likely to impact performance and therefore must be carefully considered as part of the investment review process. PEG believes that sustainability considerations should be reviewed holistically to account both for material risks and for potential opportunities that may make companies or underlying managers more or less attractive for investment.
We collaborate with clients across various sectors and investment strategies. We recently scored an A in the UNPRI [United Nations Principles for Responsible Investment] assessment for manager selection in private equity. ESG is intertwined with what we do.
Interview by Arjun Sajip