Q&A: Downing on private market opportunities
As large listed traditional asset managers seek to gain private markets exposure—some via acquisitions—Downing stands out.
We recently spoke to Kostas Manolis, the firm’s head of private market investments, about where he sees opportunities. Downing’s private market business covers three-quarters of its AUM and includes energy and infrastructure, asset-backed private equity, real estate lending and healthcare venture capital strategies.
PitchBook: How are the opportunities in private markets changing for investment managers?
Manolis: There are winners and losers, of course. Around half of our AUM is renewable energy and fortunately that was a winner given inflation and power price movements. We were already prudent on the discount rates we use for our valuations and our projects currently fall naturally outside the UK government’s new windfall tax for energy generators. Diversity helps as well, with strong FX gains from our Nordic investments. Outside this, most of our current private markets portfolio is either in stretched senior lending or minority PE with preferred returns, which we believe puts us in a much better position to weather asset price corrections.
I think these will be areas to continue deploying funds over the next year or two, now also with improved interest rate and equity pricing. I think it’s early yet, but at some point next year I expect we will start seeing quality opportunities trapped in the wrong funding structures that can be restructured out with fresh funds.
Do you see the current economic environment influencing institutional investor allocations in private markets?
Yes, I believe so. We recently commissioned a number of surveys looking at institutional investor sentiment and we found that two-thirds of institutional investors are looking to allocate 5% or more of their private markets portfolio to special situations. Also, more than 80% of UK pension schemes said they are looking to increase their allocations in the social care sector due in part to the aging demographic and subsequent greater demand.
And what about investment managers, do you think they are going back to basics in the current climate, or do you see product innovation?
We have been seeing a trend of LPs wanting more control, more direct investing and separately managed accounts, and this is not going away in the current climate.
I think that investment managers will need to be even more flexible in the future and, although they might prefer the simplicity of aggregated vehicles, LPs might want more bespoke solutions and this requires more infrastructure to support effectively. So you need a platform with more sophisticated product development and client servicing to address this at scale. And you are going to need to innovate all the time to meet investor demand.
Downing has a focus on sustainability and we have seen a bit of backlash on ESG as a result of the war in Ukraine and the energy crisis, how does this play out for you?
Yes, there has been a bit of a backlash, but this is mainly in relation to public markets. The war in Ukraine has been a reminder that energy security and defense cannot be sacrificed as we are putting at risk the integrity of the democratic Western European platform on which we can achieve so much, including all three of the ESG components.
But I still think that some of this backlash hides short-term thinking. You will have heard the expression that humans didn’t move from the Stone Age to the Iron Age because they ran out of stones. At some point we’ll stop burning hydrocarbons because the alternative will be better and we need investment and popular support to achieve this sooner rather than later. Like it or not, the green revolution is happening. And we like it, as most of our private markets business at Downing does three things: renewable energy, healthcare, and mass and affordable housing.
Downing recently sold its tech ventures business, why?
Well, we have been in the tech market for a long time, but it has become very crowded. In a market like this, you need to be laser-focused to succeed and we are now focusing exclusively on healthcare ventures.
The team now looks at investments in anything from devices, services and digital healthcare, which are areas that require deeper expertise. There is also less supply of capital for businesses in that space and, at the same time, there are increasing levels of interest from institutional investors as they like the impact that healthcare investments naturally have. This also aligns with Downing’s approach to sustainable investing and our accreditation as a B Corp.
Blockchain and similar innovations are making access to private markets easier, is there a concern that investment managers could be disintermediated?
Give technology enough time and it will disrupt anything. We have historically seen a lot of concepts through our ventures business, from automation of credit decisioning using open banking to broker disintermediation and improvements in information integrity for transactions using blockchain. However, it is easier to apply all that in public markets, where there is a lot of standardized information, or in private markets, where there are simple repetitive transactions like consumer or SME lending.
It’s much more difficult in PE, VC, infrastructure or commercial lending, as access to information is poor and you need experienced investment managers to spend a lot of time with management teams and carry out really deep due diligence. There is also a lot of deal structuring and post-transaction optimization, and all of these things cannot easily be disintermediated. We have more than 100 people in our investment team and they are busier than ever. There may be a few things that keep me up at night, this is certainly not one of them.
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