March 22, 2021
On the one hand, there is some stability in how private equity operates. Investors will seek out opportunities that show signs of a return value that outweigh any predicted risks. On the other hand, when circumstances change, different places are explored for such opportunities. Thus, just like any other industry, private equity periodically experiences trend shifts. It is natural to expect that such monumental events as we experienced last year will shape the trends for 2021. To understand better what awaits us, let’s delve into the past, present, and future of private equity.
Although there have been some early signs of it at the beginning of the 20th century, private equity as we know it today formed after World War II. Since its emergence, private equity provided funds for great ideas to materialize, especially when it was hard to find alternative ways to finance them. After the war, American Research and Development Corporation, founded by the legendary “father of venture capitalism” Georges Doriot, helped veterans start their companies, which eventually played a key role in building the business landscape we know today.
Today private equity refers to a whole set of subcategories of investment strategies, connected by way of raising funds from private investors. Yet, venture capital is still among one of its most important strategies, which helps start-ups go into business or providing businesses with early development means. Today venture capital is primarily interested in technology firms with ideas for products and services that are shaping the modern way of life.
Now, private equity firms might be more associated with another crucial strategy of theirs – leveraged buyouts. Using borrowed funds to buy out and restructure companies levers the profits after the eventual sale, making this move extremely beneficial when successful. Thus, no wonder that leveraged buyouts have, at some periods, even become almost synonymous with private equity.
Like every other industry, private equity felt the impact of Covid-19. The value of private equity deals was lagging in the first half of 2020, when the pandemic gained momentum compared to the years before. But now, we are in the aftermath of the crisis, looking to rebuild and move forward. Similar to the aftermath of any other global incident, we will need people and companies to finance the new projects and buy out the underperforming firms.
And as it is usual after calamities, all eyes are on PE firms. In an important sense, private equity trends of 2021 will form the path and shape the success of future businesses.
There are many tendencies that we have reason to expect to rise or accelerate in 2021. However, many of them can be summarized under three main center themes that will shape this year for private equity – machine learning, virtualization, and ESG.
In the last decade, we have seen an extreme proliferation of alternative data sources. It’s natural to expect the next decade to be all about advancing data analysis technology. Machine learning is part of artificial intelligence science that studies the way algorithms can learn to solve new problems without additional programming by humans. Private equity firms use machine learning to evaluate buy-out opportunities in the due diligence process and discover new firms ready for the next big investment. The ability of algorithms to develop their problem-solving abilities by constantly working on the data ensures machine learning a crucial part in the foreseeable future of private equity.
PE firms use machine learning as it highly improves the efficiency of the analysis. Automated data-handling procedures are generally much faster. Add to that the ability of the tools to improve themselves as they are being used, and you’ll get a whole new level of efficiency. Additionally, machine learning reduces the likelihood of errors as there is no human bias or weariness involved. This leads to cost efficiency, as programming-related operations are excluded and costly errors avoided.
As all the technical challenges keep being met, the main opposition facing the beneficial implementation of machine learning is the human bias against technology. Some mistrust and unwillingness to accept technological advancements still persist in PE firms. Thus, those who see the benefits of machine learning will need to take it upon themselves to find a way to reach and educate their colleagues about its importance to ensure that their company keeps up with the pace of the industry.
As Covid-19 hit, many industries had to implement remote work strategies rapidly. This increased the rate of virtualization of various private equity procedures. More and more meetings, decisions, and deals are happening online. Even after the pandemic, remote work and virtualization will keep playing an important part in private equity firms’ daily operations as once implemented. These strategies provide considerable benefits.
Continuing through 2021 and beyond, virtualization of the workflow will help to remove the barriers set by geographical distance. It also reduces unnecessary bureaucracy as moving towards remote work, we learn to recognize which procedures or documentations are nonessential and superfluous. Naturally, all that leads to improved efficiency for the PE firms.
Still, at the end of the day, additional trust that comes from shaking a partner’s hand or visiting the location to be invested in cannot be easily replicated. Therefore, in the year after Covid-19, one of the main challenges will be striking the right balance between remote and in-person. Deciding on what is to be relocated to the virtual world and what is kept in the physical will require a thorough examination of PE firms and portfolio companies’ procedures.
Evaluating the effects of investing in the broader social and environmental context has been a major theme throughout the 21st century so far. It’s expected that the significance of this theme will only grow when climate change and virus outbreaks make it evident how interdependent economics, nature, and politics are. Environmental, social, and governance investing refers to this need to consider what long-term effects particular investments are going to have. Going forward, PE firms will increasingly examine portfolio companies by their business qualities as well as their impact on society and the environment.
There is a reason why ESG investing is also called sustainable investing. It refers to the stability of societal structures in which investments are being made, and business is conducted. In return, investors are helping to create such an environment and are more assured of the future and can forecast the future with higher reliability. This leads to better-informed decisions and overall higher control over the future for investors.
Making sure that the investments conform to the high standards of ESG investing requires a very nuanced analysis of various possible outcomes. This means that private equity firms will have to handle a lot of different types of data to evaluate the investments on many levels. This goes to reaffirm the status of machine learning as a private equity trend for 2021 as data analysis technology will have to be kept up to date.
As we can see, big data analysis will remain a key theme in 2021 and beyond, as its significance has been increasing over the past decade. In one way or another, it will impact most of the private equity trends. Therefore, it is worth looking closer at the role data plays in machine learning, that is, as means for algorithms to be trained.
The important thing to understand is that well-trained algorithms don’t just improve efficiency by doing the analysis faster. They can actually do more than it’s feasible by constant programming. One way to look at it is through an analogy with driving. One can’t teach driving by simply explaining what to do. How to start the car, maybe, but not much more. Certainly not how to navigate all the different circumstances one might meet on the road. This must be learned by experience.
Similarly, it is hardly possible to program the solutions to every problem that might arise during data analysis. But algorithms can find those solutions on their own when they keep learning by encountering various types of data. Data to the machines is what experience is to the people.
When constantly dealing with data, machines can arrive at solutions that people would likely overlook without human interference. This is why it is crucial to keep feeding the algorithms with various data types, including traditional financial information and alternative data. Thus, data-intensive machine learning methods, where algorithms are heavily exposed to online data, have shown strong results in many fields, including financial modeling and marketing.
Therefore, the trends in 2021 will dictate the continuous need for PE firms to get their hands on as much data as possible.
Periods after serious calamities are always intense yet exciting at the same time. These are times to rebuild and lay the foundations for a better future. The year 2021 marks the beginning of such a period, as we are preparing for life after Covid-19. And as always, the new life that we will create will depend on where we invest. Judging by the foreseeable trends of private equity, we want to build a more sustainable future, and we are willing to use all available means for that. Machine learning will headlight the set of means for investing that will rebuild the economy in the coming years.