By Bryan Turner, Partner, Spear Capital
In late June, the Bank of England announced a surprise 50 basis point increase in interest rates. It was the 13th consecutive such rise and forms part of an ongoing effort by central banks across the globe to rein in rampant inflation. It brings the bank’s base lending rate up to five percent, the highest it’s been since April 2008 and the early parts of the Global Financial Crisis.
With economists now fearing that inflation will be sticky, rather than transient, some players in the UK private equity sector are starting to get a little spooked. For months, many have struggled to raise funds, with investors worried about their exposure. Globally, meanwhile, many private equity firms are paying the price for failing to hedge against rising interest rates. As a result, their portfolio companies have been left trying to pay off increasingly unaffordable debts.
While the alarm around rising interest rates is understandable, it doesn’t mean that private equity firms can’t find value and generate viable returns. In doing so, they could do much worse than draw from examples in Southern Africa, where investors have long had to contend with high interest rates and occasional bouts of runaway inflation.
Before looking at what lessons UK private equity investors might take from Southern Africa, it’s worth providing a little more context around interest rates and inflation in the region.
Take South Africa, for example. It’s the region’s most advanced and industrialised economy and home to a robust private capital sector. While the sector hasn’t been immune to global macroeconomic pressures, it is still growing. And that’s in a country where even the Global Financial Crisis wasn’t enough to push interest rates below five percent (a mark only breached once large parts of the global economy shut down thanks to COVID-19). Even the current base rate of 8.25% is lower than the 12% rates the country saw in 2008. It’s also seen persistent inflation, with rates last falling below three percent in 2005.
Granted, the country’s private capital sector may be dwarfed by those in more developed markets. But it’s certainly large enough to demonstrate that it’s possible to find investable companies that generate returns even in economies with higher interest and inflation rates.
That’s to say nothing of a country like Zimbabwe, whose economic challenges are well chronicled. Our own experiences as private equity investors demonstrate that, even within the most turbulent economies, there are companies worth investing in.
There are a couple of things that set those companies apart. The first is resilience. If a company has survived for any length of time in an economically turbulent environment, there is likely something worthwhile in it. Dig a little deeper and chances are you’ll find potential opportunities for further growth. With global macroeconomic turbulence unlikely to slow down anytime soon, resilience is going to be an increasingly important quality in potential portfolio companies.
Another important factor is being able to produce real value. In years following the Global Financial Crisis, interest rates were so low that many now refer to it as the “era of free money”. This allowed investors to take risky bets on companies and let them run at a loss for years in the hope of a big payday down the line. The technology sector in particular benefited from this situation even though, all too often, these companies didn’t produce any real value. Even some of the most successful technology startups to emerge from this era have been accused of disrupting industries without presenting viable solutions in the wake of that disruption.
Seasoned investors in Southern Africa haven’t always had this luxury. As a result, they’ve had more success finding companies that deliver real value in their day-to-day operations. Make no mistake, the region’s technology sector has had its own periods of frothiness but they’ve been nowhere near the bubble-style levels seen in other markets.
It shouldn’t be surprising then that in 2021 (the most recent year for which figures are available), the sectors that received the highest levels of investment in this region were infrastructure, retail, and energy. These are all sectors that, along with others such as food manufacturing and processing, that are vital to economic growth in the region. They’re also among the best-positioned to create jobs and contribute positively to the communities they operate in.
So, given the current macroeconomic climate, I believe there’s a strong case to be made for UK private equity investors drawing lessons from Southern Africa. Our experiences in these markets show us that companies that are resilient and produce real value are capable of consistently producing solid returns, even during periods of high interest rates and inflation.
There’s no reason anyone playing in the private equity space shouldn’t look for similar kinds of companies to invest in at home and further afield.
Private equity refers to investment funds that buy and restructure companies not listed on public exchanges, aiming to improve their value and eventually sell them for profit.
Interest rates are the cost of borrowing money, expressed as a percentage of the total loan amount, and can influence economic activity and inflation.
Inflation is the rate at which the general level of prices for goods and services rises, eroding purchasing power.
A financial crisis is a situation where financial institutions or assets suddenly lose a large part of their value, often leading to economic instability.
Resilience in business refers to a company's ability to withstand or recover quickly from difficult conditions, such as economic downturns or market volatility.
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