Where Private Equity Goes in 2020

Private equity leader KKR released its latest macro outlook this week.

Head of Global Macro & Asset Allocation Henry McVey outlines where KKR thinks the best opportunities will be this year.

McVey is not as optimistic this year as he had been in years past writing.

“Today, we see the global capital markets through a different lens, one that is certainly less rose-colored than the ones we were wearing last year,” he writes.

“Indeed, unlike last January, we now think that the U.S. stock market has already priced in a robust economic recovery in the first half of 2020. By comparison, our predictive earnings model suggests only a modest recovery occurring by the second half of this year. We also think that there may not be enough political risk priced into the U.S. market at current valuations, and believe the private growth markets still need to unwind further.”

Private equity leader KKR on the Markets

Given that expectations are for rates to stay low around the world, the KKR macro team continues to suggest that owning what they call cash flowing collateral with upfront yield.

This includes things like cash producing infrastructure projects and developments, real estate credit, and real estate equity will allow investors to profit regardless of how the economy plays out in 2020.

The firm also thinks that there will be increased volatility in 2020.

They recommend “leaning in” to selloffs in the markets to buy “attractive cash-flowing assets at reasonable valuations.”

McVey and his team see several factors that will lead to higher volatility in equity and credit markets this year. They are:

• U.S. politics;
• Worsening geopolitical conditions;
• The lack of effective Q.E. compared to prior years;
• A top in corporate margins; and,
• EBITDA adjustments in stock valuations.

In fixed income, KKR notes: “Consistent with our macro theme to lean into dislocation and buy ‘spicy’ debt (but not too ‘spicy’), our suggestion is to pursue a strategy of accumulating positions in credit yielding instruments where prices reflect some of the current market uncertainty while avoiding the tails.”

Outlook 2020 for the Credit Markets

KKRs macro team also thinks investors should avoid areas of the credit markets where underwriting standards have been weak. This includes areas such as unsecured consumer credit and subprime card loans.

They also warn that BBB rated bonds are now half of the high credit market. We could see a flow of downgrades that creates a wave of fallen angels.

This is especially tur of those credits in the volatile healthcare and energy segments of the investment-grade marketplace.

McVey concludes his report by telling us that “Above all, though, the best advice we can give our readers is to take a step back and dust off many of your old valuation and accounting books. The new reality that we will face this year will likely benefit those investors who will go forward by actually going “back to the future” and focusing on where actual free cash flow – not just the promise of it – is undervalued relative to expectations. And in doing so, we believe that investors will be in the best position to be able to Play Your Own Game in 2020 and beyond.”

You can read the full report here.

By: Tim Melvin