Calling all LPs! Thanks for joining me (John Bailey, Co-Founder at OneFund) for another edition of Capital Call. A bi-weekly private equity newsletter from LPs for LPs. 

The mission of Capital Call is to deliver concise, top-notch insights and updates from the private markets tailored to what matters for LPs. 

This week we will be looking at: 

• How Real Assets Are Projected to be Forefront of the PE Recovery

• Fundraising updates and VC/PE reports

• GP Perspectives from Ray Dalio & Sharon Kilmer

Real Assets Projected to be Forefront of 2024 PE Recovery

In 2023, private infrastructure experienced a sluggish transaction year as inflation and rising interest rates widened the gap between buyers’ and sellers' value expectations, which was exacerbated by a freeze in traditional credit markets.

KKR’s latest review of real assets reveals only $124 billion in global infrastructure activity in the first half of 2023 compared to $190 billion in 2022 and $235 billion in 2021.

However, today’s uncertainty also provides a catalyst for real assets to shine, demonstrating the value of an asset class as a hedge against both inflation and macroeconomic stress.

In this week’s capital call, I’ll dive into why GPs are optimistic about real assets going into 2024 and the sectoral themes most important to GPs and LPs alike.

Real Asset Opportunities: Decarbonization, Digitalization, and Deconsolidation

Looking to 2024, GPs predict an increase in transaction activity as capital markets warm. Infrastructure assets are appealing to GPs due to their sticky customer bases, strong market positions, and contractual and regulatory protections that offer downside protection. This combines to value these assets at a premium.

GPs are viewing real assets as a risk-mitigated, collateral-based avenue for gaining exposure to secular trends like digitalization, decarbonization, and deglobalization with high long-term growth potential.

KKR highlights the three key areas of thematic opportunities: decarbonization, digitalization, and deconsolidation. Decarbonization is largely being driven by government policy, with the Inflation Reduction Act (IRA) providing over $250 billion in initiative funding in the clean energy sector. 

Infrastructure is seeing similar opportunities, with KKR projecting a $15 trillion gap in government infrastructure spending and society's needs, opening up vast opportunities for GPs to get involved.

Finally, deconsolidation is another driving trend as large, aggregated corporates are divesting capital-intensive assets to free up cash on the balance sheet, further allowing GPs to step in as capital providers and acquire strong assets.

Creative Dealmaking to set the Stage in 2024

KKR projects successful deals to be far more creative than previously vanilla M&A, involving structures such as secondaries, NAV loans, convertibles, and more.

In their review, KKR found that most successful transactions in the current environment involved flexibility, access to different pools of capital, strong relationships with companies and management teams, and creativity. GPs should act creatively not to take more risk, but as a tool to ensure amplify downside protections to generate attractive risk-adjusted returns.

A prominent example appearing in the market is sale-leaseback arrangements instead of traditional spinoffs. Companies can unload cost-center assets and allow private operators to manage the asset, typically involving a team skilled in improving operations and processes.

Key Themes for GP Success in Real Assets

For GPs to succeed in operating real assets, KKR provides the following recommendations:

1. Optimize the Portfolio:

Focus on assets with direct inflation linkages, relative independence from economic cycles, and strong market positions or protection from competition. The preference lies in investment scenarios where success depends on controllable factors, such as optimization plans and structural changes, rather than economic and market fluctuations..

2. Optimize the Market Opportunity for Portfolio Companies:

In response to an uncertain economic environment, provide a strategic reimagining of go-to-market strategies for portfolio companies. Top-line revenue is a great place to drive impact with portfolio companies.

3. Optimize Operations:

Operating within the private equity business, the focus is on infrastructure assets, and operational improvement is a key tool for value creation. 

Successful real assets investments often involve GPs who have operating partners deeply entrenched in daily operations. In 2024, GPs must be laser-focused on value creation as an important tool to combat the effects of higher inflation and interest rates. 

Overall, vintages that come during difficult market environments tend to perform well, which is why KKR and other GPs are heading into 2024 with optimism. Real assets can become the catalyst that heats up PE dealmaking as GPs find comfort in deploying capital in de-risked assets with the major tailwinds outlined above.

Updates from Across the Ecosystem

Fundraising

📈 Brookfield Raises Record $30 Billion For Flagship Infrastructure Strategy

📈 Ares Management racks up $3.3 Billion for Real Estate and Secondaries Fund

📈 Mid-Market Buyout Shop Beekman raises $550 Million for Fund V

Reports

🔬 Apollo: Where to Find Opportunities in a Shifting Economic Landscape?

🔬 Bain: Telecom M&A Q3 Update

🔬 Brookfield: The (New) New Macro

GP perspectives:

Ray Dalio (Founder, Bridgewater Associates)

Though seemingly simple, Ray Dalio, founder of Bridgewater Associates, provides an important reminder to assess real returns by comparing earnings in relation to prices of other goods. This can be done by discounting cash flows by a projected CPI figure each year, showcasing returns in today’s dollars. 

Real assets typically provide a strong hedge against inflation, especially infrastructure, as they often feature contracts linked to CPI or other escalators. Likewise, LPs should assess their GP performance in terms of real returns, as recently high inflation may seem like companies are growing their cash flows when in reality they could be stagnant.

Sharon Kilmer (Managing Director, TPG Angelo Gordon)

Sharon Kilmer, MD at TPG Angelo Gordon, believes net lease assets tend to be better bond substitutes than other opportunities. In particular, she draws attention to triple net leases, where the costs of structural maintenance and repairs to the tenant in addition to rent, property taxes, and insurance premiums are passed along to the tenant. 

This provides extremely stable cash flows, allowing GPs to secure favorable financing terms that are difficult to come by in today’s environment. Additionally, Kilmer recommends investments in industrial properties that are mission-critical to corporates, providing further strength to triple net lease agreements.

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