Fredrik Green is Zinqular’s new Chief Strategist.
This interview was conducted by Emma Nilsson – Zinqular Group Director of Media & Communications.
Emma: In general, what is your take on COVID-19 pandemic and its impacts on society and the global economy?
Fredrik: The COVID-19 pandemic is an unwelcome reminder of just how much health matters for individuals, society, and the global economy. For the past century or more, health improvements from vaccines, antibiotics, sanitation, and nutrition, among others, have saved millions of lives and been a powerful catalyst for economic growth. Better health promotes economic growth by expanding the labor force and by boosting productivity while also delivering immense social benefits.
The COVID-19 pandemic has accelerated profound shifts in how economies and societies operate across four dimensions: – inequality, geopolitics, sustainability and the joint macro policy revolution.
The good news is we have the vaccines available. I think the rapid availability of the COVID-19 vaccines is having a profound effect on the world. More than 12 billion vaccine doses have been announced by manufacturers for release in 2021. The earth’s population is 7.8 billion. Coverage for a first dose seems adequate, until you consider the logistics. Manufacturing is concentrated in a handful of countries; regions without manufacturing must import the vaccine. We think very-high rates of vaccine adoption would be epidemiologically and economically beneficial. What’s needed is collective action on an unprecedented scale among manufacturers, governments, and other interest parties.
My take is that, 2021 is the year of transition. Excluding any unexpected catastrophes, the new normal is going to be different. We believe this year 2021 will provide greater perspective on the investment implications of our fast-changing world. We look forward to working together with our clients to help shape their portfolio for the future. We think 2021 will bring renewed growth, a renewed hunt for yield, new leadership, and a new, and renewable, future.
Emma: What, if anything, distinguishes the classic COVID-19 from the new variant/mutations COVID-19? How dangerous are these new variants?
Fredrik: I infer from the Greek and Roman mythology, where a multi-headed water monster would immediately regrow a head after one was chopped off. The serpentine creature, that was eventually killed by Hercules, comes to mind as governments and health experts grapple with mutations of COVID-19. Though vaccines are highly effective at stopping the original virus, they are less well-equipped to defeat its variants. The world faces a lengthy battle. Viruses are constantly mutating: COVID-19 has so far spawned some 4,000 variants. Although many display the same characteristics as the conventional variety that emerged in the Chinese city of Wuhan, a trio of mutations named after the places they originated are of particular concern. The Kent variant, first detected in the British county, spreads more easily. A Brazilian version is also causing concern. The South Africa mutation, is the most worrying. It is suspected to be 70 percent more transmissible than the original and has already spread to 32 countries. Crucially, its mutations give it a kind of cloaking device that allow it to hide from the antibodies created by vaccines. This raises the risk of people who have had jabs still getting sick. The UK government was so concerned about the new mutation earlier this month that it embarked on a door-to-door testing blitz of 80,000 people after detecting just 11 cases of the variant in people with no links to recent arrivals from South Africa.
Emma: Follow up to the previous question, will the current vaccines not provide some form of protection to the COVID-19 variants?
Fredrik: I think, there are two big questions about the current crop of vaccines. Can they protect against infection from a new variant? And even if they don’t, can they provide enough antibodies to lower the risk of serious illness and death? Data is too patchy to provide a definite answer. A recent study on genetically engineered blood samples of the variants showed the jab developed by Pfizer and BioNTech was effective on the Kent and South African mutations. Other vaccines offer far less protection against the South African variant, with the AstraZeneca jab only reducing the risk of developing mild to moderate COVID-19 by 22 percent, compared with about 70 percent in trials involving the original virus. This information, revealed in a study last weekend, prompted the government in Pretoria to block the use of AstraZeneca’s vaccine until there is more data. Moderna’s vaccine produces just one-sixth of the antibodies when confronted with the South African variant than it does for the original virus.
Other jabs are more versatile. Johnson & Johnson’s level of protection against moderate and severe COVID-19 was 57 percent in its South Africa trial and Novavax’s efficacy was as high as 60 percent for the prevention of mild, moderate and severe COVID-19. That’s lower than the protection provided against the mainstream strain, but still above the 50 percent threshold typically set by regulators for approving a vaccine. News of Novavax’s effectiveness against the South African variant prompted the company’s share price to double on Jan. 28. Still that’s limited consolation for Western governments which have bet heavily on the Pfizer, Moderna and AstraZeneca vaccines to inoculate their populations and reopen their economies.
Reliable protection against the new variants may have to wait for new vaccines specifically designed to block them. Developing, testing and manufacturing such booster shots will take around six months, though, and a further three to five months to roll out across the globe. Mixing and matching existing vaccines, a process known as heterologous prime boost vaccination, might provide a speedier solution. This is being tested on humans in a trial run by the University of Oxford.
Emma: What else can the authorities do to stop transmission of these new variants? Does it mean lockdowns will last longer?
Fredrik: There are several ways of doing this – the obvious one inv olves using Chinese and Korean examples. China and South Korea have shown the way by testing tens of millions of people within short span of time when they detect a handful of new cases. Germany is looking to test commuters crossing its borders to identify those carrying the more infectious mutations. A more drastic alternative is to impose strict quarantines on new arrivals, as implemented in countries including New Zealand – where returning travelers spend a mandatory 14 days in a hotel, at a cost of nearly $3,000 for a couple. But even that strategy has limitations. The Australian state of Victoria, which has a similarly strict regime for arrivals, on Friday imposed a five-day lockdown following an outbreak of the British variant in Melbourne.
Your next question regards longer shutdowns – I think though vaccines will provide people with some protection, they may not be enough to keep cases to a level that would allow widespread easing of restrictions. The dilemma for governments is that relaxing lockdowns would allow the mutations to spread more quickly, in turn spawning new variants that will be even better at evading vaccines. All of this will delay the moment when governments can declare the pandemic to have been defeated. Moreover, countries that have been more successful at limiting the spread will be reluctant to open their borders.
Emma: What does this mean for companies and investors?
Fredrik: Investors seem oblivious to the risks of a delayed recovery. The S&P 500 Index is trading close to its all-time high, buoyed by optimism about rapid vaccine rollouts. Equity analysts expect the 1,585 companies included in the MSCI World Index to report 8 percent higher net profit this year, on average, than in 2019, according data from Refinitiv. They project next year’s earnings will be 24 percent above pre-COVID-19 levels.
Industries like airlines and hospitality are particularly vulnerable to any prolonged lockdown or delayed loosening of travel restrictions. Governments will also face pressure to further extend fiscal support to companies and individuals, as will central banks. The world deserves great credit for rapidly developing vaccines which can defeat the virus. The worry is that, having chopped one head off the Hydra, new ones are growing back even faster.
Emma: How is the COVID crisis and the recovery shaping the global economy?
Fredrik: We at Zinqular think that the global economy recovery is being shaped by several forces. I will like to share two of them.
The first is the return of confidence unleashed a consumer rebound. As consumer confidence returns, so will spending, with “revenge shopping” sweeping through sectors as pent-up demand is unleashed. That has been the experience of all previous economic downturns. One difference, however, is that services have been particularly hard hit this time. The bounce back will therefore likely emphasize those businesses, particularly the ones that have a communal element, such as restaurants and entertainment venues. China’s profile illustrates a larger point. The first country to be hit by the COVID-19 pandemic, it was also the first to emerge from it. China’s consumers are relieved—and spending accordingly. On Singles Day, November 11, the country’s two largest online retailers racked up record sales. That wasn’t just a holiday phenomenon. While manufacturing in China came back first, by September, so had consumer spending. Except for international air travel, Chinese consumers have begun to act and spend largely as they did in pre-crisis times. Australia also offers hope. With the pandemic largely contained in that country, household spending fueled a faster-than-expected 3.3 percent growth rate in the third quarter of 2020, and spending on goods and services rose 7.9 percent. The point is that spending will only recover as fast as the rate at which people feel confident about becoming mobile again—and those attitudes differ markedly by country.
The second is globalization rewiring, and supply chains rebalance and shift. Think of it as “just-in-time SHOCK.” The “SHOCK” represents “sudden provisional upsetting” meaning more sophisticated risk management (within manufacturing system). The COVID-19 pandemic revealed vulnerabilities in the long, complicated supply chains of many companies. When a single country or even a single factory was “offline”, the lack of critical components shut down production. Never again, executives pledged – then begins the great rebalancing and globalization rewiring. As much as a quarter of global goods exports, or $4.5 trillion, could shift by 2025. Once businesses began to study how their supply chains worked, they observed three things. Number one, disruptions aren’t unusual. Any given company can expect a shutdown lasting a month or so every 4 years. Such shocks, then, are far from surprising: they are predictable features of doing business that need to be managed like any other. Number two, cost differences among developed and many developing countries are narrowing. In manufacturing, companies that adopt Industry 4.0 principles (meaning the application of data, analytics, human–machine interaction, advanced robotics, and 3-D printing) can offset half of the labor-cost differential between China and the United States. The gap narrows further when the cost of rigidity is factored in: end-to-end optimization is more important than the sum of individual transaction costs. Number three, most businesses do not have a good idea of what is going on lower down in their supply chains, where subtiers/sub-subtiers may play small but critical roles. That is also where most disruptions originate. None of those things means that multinationals are going to ship all or most of their production back to their home markets. There are good reasons to take advantage of regional expertise and to be in place to serve fast-growing consumer markets. But questions on security and resiliency mean that those companies are likely to be more thoughtful about the business cases for such decisions.
Emma: What is your take on the future of work in the post COVID world?
Fredrik: There is no doubt the future of work has arrived ahead of schedule. Before the COVID-19 crisis, the idea of remote working was in the air but not proceeding fast enough. But the pandemic changed that, with tens of millions of people transitioning to working from home, essentially overnight, in a wide range of industries. For example, in Japan, fewer than 1,000 institutions offered remote care in 2018; by July 2020, over 16,000 did.
We estimate that more than 25 – 35 percent of the global workforce (most of them in high-skilled jobs in sectors such as finance, insurance, and IT) could work the majority of its time away from the office—and be just as effective. Not everyone who can, will; even so, that is a once-in-several-generations change. It’s happening not just because of the COVID-19 crisis but also because advances in automation and digitization made it possible; the use of those technologies has accelerated during the pandemic.
There are two important challenges related to the transition to working away from the office. One is to decide the role of the office itself, which is the traditional center for creating culture and a sense of belonging. Companies will have to make decisions on everything from real estate (Do we need this building, office, or floor?) to workplace design (How much space between desks? Are pantries safe?) to training and professional development (Is there such a thing as remote mentorship?). Returning to the office shouldn’t be a matter of simply opening the door. Instead, it needs to be part of a systematic reconsideration of what exactly the office brings to the organization.
The other challenge has to do with adapting the workforce to the requirements of automation, digitization, and other technologies. This isn’t just the case for sectors such as banking and telecom; instead it’s a challenge across the board, even in sectors not associated with remote work. For example, major retailers are increasingly automating checkout. If salesclerks want to keep their jobs, they will need to learn new skills. In 2019, we estimated that more than half of employees would need significant reskilling or upskilling in the next 2 years.
Emma: How do you build operating groups or value-creation portfolio groups that is essential for creating alpha in the COVID (and post-COVID) environment?
Fredrik: Among prevailing conditions, GPs need to manage for alpha. Even under COVID environment investors have not tempered their return expectations as a result of slowing economic growth. There are few ways of creating alpha. However, there’s no silver bullet, one way is to start with a model or a framework. We have our own playbook, by name Open FrameWORX Platform (OFP), “Open” because its agile; can be modified to fit any relevant playbook. The OFP has four core elements. The OFP uses Zinqular’s proprietary systems together with tools, models and data that guides us to focus on few key levers rather than trying to do several things at once. You need to have big ambitions, but start with some relatively small initial steps that we can accomplish quickly. It’s generally in one or two areas that there’s an opportunity to show some results.
Next is achieving excellence in talent, governance, and organization. Update processes and structures. Front-load portfolio companies’ talent decisions and match talent to value. Formalize and refine the talent pipeline for GPs. Assess PE firms’ organizational health. Evaluate fund’s value proposition for talent. Then it’s about getting the right people and matching those objectives with talent. The other issue is time scale; how quickly you’re able to do this. Normally, it takes a year before you find the right people into the right positions, and the right plan in place. That’s quite long.
You need to develop a hypothesis, and have a very detailed plan ready, pre-investment. Post-investment, quickly get the management team on board, modify the plan and execute the plan, get the right people in place within the first three to four months. If you hit the ground running and are at takeoff speed in year one, then generally the investment is off to a good start, and that helps really well.
Next, get the digital and data piece right as it is key part of alpha creation for most businesses. Some of this relates to business reposition company’s exit strategy, and whether you can scale the business up dramatically, or create a larger scale business with better operating leverage, margins, and valuation multiple as a result of organic growth.
In some investments we had stakes in lower growth, more commoditized-type businesses. We divested some of the lower-margin business lines, and focused on areas like EV supply chain, or medical equipment. Higher margin, high growth.
You not only change the margin structure of the business, you also change the multiple by entering higher margin, higher growth businesses. The “iron meets the fire” on the actual execution of these plans. How you execute, and how long it takes you to execute, because its operating against the clock.
Emma: We have also noticed concentration of funding with large GPs in the past few years. LPs are narrowing down the number of funds they are investing in. What’s your outlook for this, and what are some of the things that GPs should be doing in order to be on the positive side of this trend?
Fredrik: I think there is a massive direction towards aggregation funding into larger funds. The PE market has made it easier for prospective LPs to evaluate GPs’ performance, which has contributed to the concentration of funding with large GPs. Our internal data indicates that past performance, deal pipeline, and duration of track record are now the top three factors in GP selection. At the same time, LPs prefer to deal with a limited number of funds for operational efficiency and compliance reasons. COVID-19 might have accelerated this trend and this may favor GPs that are already familiar to LPs. For e.g. If you are an LP and you have a large program, you need to have relatively large commitments in order to move the needle on your own program. You also want to avoid being overly exposed to any one fund, so you generally need to be in larger funds, larger programs in order to accommodate the size of commitment that you want to make. Most LPs are resource constrained, so from a productivity standpoint, they want to have larger relationships with your GPs. Increasing productivity works in everyone’s benefit. There are benefits to scale, and I think this trend will continue.
Make no mistake that this industry goes through evolution in some ways. You’re always going to have some very specialized, entrepreneurial, younger, newer firms that are on the first or second fund, or more boutique-type operations, where younger teams are growing and generating great returns, and are doing more niche strategies perhaps, or smaller deals. Then there is a lot of movement towards, and benefits from, a concentration of larger funds that are able to build scale in their own organizations, but also go after scale assets and drive change in the businesses that they invest in. The mid to large end of the market in some respects is less competitive, because there are fewer buyers for those assets. They tend to be extremely disciplined buyers. When you have billions of dollars at stake, you are not creating a very diversified portfolio where some are going to fail. You make sure every single investment is going to be fine or good. Generally, most players at that end of the market are pretty careful about the way they underwrite, which creates a self-regulating discipline in the market. As the deal size increases, you generally have fewer players. The deals are more intermediated, but you’d be surprised at the number of deals that we see that are not intermediated for a variety of reasons. It’s a more bilateral-type situation. It could be a take-private, it could be a company where there is a pre-existing relationship, or it could be a strategic discussion where you have an asset that you could combine with the business. There’s lots of reasons why things don’t always go the auction route.
That ability to generate consistent returns on large amounts of capital, and to let that compound over time, will have the largest absolute dollar-weighted impact on investors’ PE allocations, as opposed to a smaller outsized return, which doesn’t have as big of an absolute impact on your program. That will continue.
Emma: How do you see the various deals being done and the amount of companies becoming available for PE investment changing in the next few years?
Fredrik: My take is deals flows will depends on PE firm’s playbook. For e.g. the deal flow developed within minority/growth capital industry where companies need equity capital to expand their business will include everything from generational change to corporate divestitures. In the COVID-19 era, we’ve seen big market dislocations creating opportunities with take-private situations – i.e. cyclically in emerging markets, which tend to go through periods of big swings. Liquidity flows in and out in waves. When liquidity dries up, markets fall, and companies become distressed.
In some markets, we see a lot of public companies where valuations have halved, or more, as a result of stress on the economy. You also have PE firms that own companies in their own portfolios that have become public companies, or were originally public, that have been marked down dramatically in price, and where there’s an opportunity to do a take-private with one of your own portfolio companies. As our industry do more buyouts, then one PE firm buying from another PE firm will become increasingly common. That sounds like a low-return strategy, or a hard to understand market, but it’s not.
We can infer to IPOs, which are primary issues while most of the market trading is secondary by design. It a similar situation in private markets. The assets get bought and sold for various reasons. It’s not always because one fund feels like the returns have been maximized so it’s time to sell. It’s generally to do with the lifecycle of an investment. You have a hypothesis, you go in, build it and you have a fund life of say, 10 years. You have an investment horizon of five or six years. There comes a point when it’s time to sell, you’ve made your money and you move on. Generally, those assets perform quite well through the second wave of ownership and beyond. In similar trend, there will be an increasing amount of transactions that involve companies where corporates decide that they have had a change in strategy and they want to divest.
In the current COVID environment, there may be more carve-out opportunities because companies may have liquidity or short-term dislocations on their balance sheet. That’s quite interesting from a PE perspective. Also, the geopolitical realities of the world today are a major issue for all of us. It creates opportunities in that PE firms may want to decouple. PE firms may want to refocus on one geography versus another, and maybe exit one geography as a result of geopolitical issues. You’re certainly seeing deal flow from continuing generational change happening at the large buyout end of the spectrum in selected markets for e.g. Central & Eastern Europe and Asia.
Emma: Recently, we see there is a lot of dry powder in the market. Is the industry disciplined enough to avoid driving up prices as it deploys that capital?
Fredrik: First of all, at Zinqular we are very disciplined investor. It’s an agile business. You need to adapt; if you’re not disciplined, it shows up in your returns and you go out of business. If PE firms can continue to add value to the companies that they invest in, then investors will still benefit from the kind of illiquidity and alpha creation that happens through a PE strategy, provided it’s done in a disciplined way. The world today is different in that we have a very low interest rate environment. The returns on capital are low. The US Treasury market, a $20 trillion market, generates about a 1 percent return for investors. There’s a lot of capital that used to earn, say, 4–5 percent that’s now getting 1 percent, and so is looking for other places to invest. That filters through the entire chain of investors, and the investment returns that people are seeking to generate.
The way you generate that return needs to be suited to the environment that we’re in today, where valuations are high. It needs to encompass buying the right company in the right sector with the right profile and growth, but also a plan to drive extra growth, margin, and exit multiple once you own and have repositioned the business. Investors need to consider how they can benefit from placing better leadership into a company, or by implementing digital transformation.
Overall, the industry will continue to thrive because there is such demand for generating returns above and beyond what is available to public market investors.
Emma: Thank you for your time.
Fredrik: Thank you.