Braham Moondi:
Hello, everyone.
Welcome to our second episode of BDO’s PE Market Pulse, where we invite a leader within the private equity ecosystem to share their thoughts on current market activity.
I'm your host Braham Moondi, Assurance National leader of BDO Canada's Private Equity Practice, and I have the immense pleasure of having Erem Kassim-Lakha joining us today. Erem is the senior managing director of Value Creation Equities at Ontario Teachers’ Pension Plan. She's a seasoned transformation leader who has spent the past 20 years in senior operating roles around the globe driving transformative growth.
So welcome Erem.
Erem Kassim-Lakha:
Nice to be here. Thank you.
Braham Moondi:
So we'll jump right into the questions here. As one of the largest institutional investors in the world, Ontario Teachers’ has a truly global outlook on investing, and often with a longer-term horizon. Looking back at 2023, what were the most significant global trends that defined the year within private equity and private capital markets?
Erem Kassim-Lakha:
Well, great question. And nothing like starting off with a really, really tough one. I would say that we see four main trends at play, really, which make the current private equity investing environment probably one of the hardest and most challenging periods since the global financial crisis.
And while COVID feels like a while ago, in some ways it brought to the forefront a few different forces, which are actually all at play at the same time at the moment, and fundamentally reshaping investing in the way in which Alpha is created.
So let me go through those four very quickly. I think the first is the end of hyper-globalization and hypergrowth following COVID. What we see is the ongoing decoupling of U.S. and China with firms diversifying operations away from China. We see higher for longer inflation and higher interest rates than we've seen for a very long time in private equity. And this is all happening while at the same time we have lower productivity in most of the large economies, certainly since the GFC. So that's sort of the backdrop.
The second trend is the politicization of the marketplace. So political polarization occurring in many countries. The geopolitical macro environment is realigning. We don't quite know how that will eventually end up. But certainly, the tectonic plates are shifting. And what this means really is that scenario planning and agility are really, really key for global investors, whereas they used to be able to commit to certain geographies or certain concepts for a long time or invest in things for a long time. They're having to be much more agile because fundamentally growth and where growth comes from is changing constantly. And how companies operate as a result is having to change very fluidly as well. And even in Canada, we've seen a significant increase in politicization since the 2021 Canadian election. So that's new for Canada.
The third main trend is the push to zero carbon and green investing. As we transition to a low carbon economy in response to climate change, we are seeing opportunity ease for sure. But we're seeing more pressure on businesses. We're seeing increasing social inequity and depleting natural capital. And on the latter, we've seen during the course of this year a focus on protecting biodiversity, which will probably follow in the footsteps of climate change in terms of disclosures.
And then lastly, we've seen the rapid rise of gen AI with the release of Chat GPT. Really, it's AI’s iPhone moment. We don't believe it's hype. We believe that Gen AI tools are starting to really help companies boost productivity in different ways.
Braham Moondi:
What are some of the key areas of focus for Ontario Teachers’ this year from a value creation perspective?
Erem Kassim-Lakha:
So I would just say that there have been value creation efforts across Teachers’ for some time. We actually have value creation efforts in our three different asset classes. But this year, we've put extra focus on scaling up our efforts across our main asset classes in order to help our portfolio companies build greater resilience to compete in the environment that we just spoke about. And we believe that these efforts will actually be really helpful for generating the alpha as the days of cheap leverage and lower interest rates are really gone. And so what this means is that there's been much more involved ways for management and investors to work together.
I'll give you a couple of examples. The first one is a North American leading food business that we own. We've helped the management team over a number of years expand the number of plants to meet growing demand. We've helped management look at automation to deal with labor shortages. And we've also looked together at smart pricing to help offset inflationary pressures. So really, a wide variety of levers being looked at and being executed on by capable management teams.
Second example is another leading North American industrial services business where we've worked with management over time to basically in-source various franchises and become a very large North American player in the space. Right now we're actually working with management to look at the cost base in great detail and we're bringing some expertise, cutting-edge expertise to the table.
And then I think the third example that we can talk about is we own a large European education business, which together with the management team, we've helped internationalize over the past many years, really doubling the number of sites that the company operates. Currently, we're actually working on helping the management team reset its five-year strategy under a longer hold. And we're looking at plans to really focus on the organic side of the business to drive top-line sustainable margin growth as well.
So you can hear here there is active involvement and active collaboration with management, really looking at a host of levers. And that gives you a sense of what we're doing in a few examples across the portfolio. It's about going through different angles and seeing where value can be added and working in collaboration with management.
Braham Moondi:
That's amazing. Thank you, Erem.
So as I have previously mentioned, Ontario Teachers’, a global investor, I want to get your thoughts about how Ontario Teachers’ Pension Plan looks at sustainability. I know you mentioned a little bit about carbon zero or net zero. There's a lot of conversation about ESG metrics and the reporting requirements by ISSP. So I want to hear your thoughts about working with companies and keeping sustainability as a core part of the value creation agenda. What are the things you're seeing?
Erem Kassim-Lakha:
Yeah, so I guess, big picture on the topic of sustainability. We are seeing global warming now at unprecedented new levels that is causing physical impacts in the environments in which we operate, and really the number of disasters, if you will, has actually grown. So sustainability and the effort around sustainability is not a nice-to-have, it's a must-have, and that's how we view it.
Sustainability reporting is important because it drives transparency on how companies are actually taking action to reduce carbon emissions in the environment in which they operate. So we definitely embrace the ISSP sort of headline measurement. It's really important that there's sort of a global standard.
So how are we sort of leaning into this opportunity? Well, I think everybody will know that Teachers’ is committed to achieving a goal of net zero by 2050 with interim goals of 45% emissions intensity reduction by 2025 and 67% by 2030. So these are really bold commitments. And the way we're leaning into that is through really helping to accelerate the energy transition. And that could mean doing traditional LBOs, but that could also mean investing into different climate solutions, green bonds, transition assets.
And, you know, earlier this year, Teachers’ acquired a majority stake in a business that helps develop renewable natural gas across North America. And we committed to capital of about 250 million. These are new examples of innovative ways to back the energy transition and, of course, on top of new, innovative ways that I've just described here across the different sectors in which we invest. We're actively working with management to help achieve those goals of net zero by 2050.
Braham Moondi:
There's definitely an increase in appetite here with these types of investments. So that's great that that's the direction that Teachers’ are also going in.
So Erem, we're in December, and I have to ask this question. What are your predictions for 2024 and how can private equity firms prepare to navigate the incoming changes effectively?
Erem Kassim-Lakha:
Yes. Well, I think there is probably consensus that we are going to continue to see a bumpy next 12 months, both in terms of deal-making and in terms of continued pressure on companies in which we invest. You know, inflation, though it might be peaking, will remain sticky, probably unwind slowly. Wage inflation is still driving tight labor markets, and interest rates again, while they may have peaked, the headline rates are still not going to come down much in the next 12 months. So this actually means that M&A and corporate investments are expected to remain muted. That also has an impact on the private equity deal market as well.
And I would say, you know, watch out for interesting investments into AI and into the energy transition space, which may be the bright sparks as we look into 2024. My view is that the companies who will be the winners in 3 to 5 years will be those who took the bold steps now, during this period that we're facing, to transform and to reshape. And I think there's a fantastic opportunity to work closely with management on value creation. Probably one of the most exciting periods, actually, to do that.
Braham Moondi:
No, for sure. The only thing constant here is change.
So, well, that's all the time we had for this episode.
Again, I really want to thank you, Erem, for taking the time and joining us today. This was amazing.
And thank you to all of our viewers for joining.
Tune in to our next session in February, where we will kick off 2024.
Erem Kassim-Lakha:
Goodbye.