The Alts Investments BlackRock’s Avoiding — And the Ones It Can’t Get Enough Of
“I do think in private equity, you’ve absolutely seen a shift in sentiment, particularly in the larger end of the market,” says Edwin Conway.
Edwin Conway, who grew up in a dairy farming community in Ireland, seems like an unlikely fan of fake leather. But during an interview, the global head of BlackRock Alternatives says he was “blown away” when he first felt the texture of a swatch of faux leather made from mushrooms by a late-stage venture company called MycoWorks. “The softness of the material is extraordinary,” Conway laughs.
Conway goes on to describe how MycoWorks eliminates the killing of animals and replaces that resource-intensive process with mushroom farming, an operation that is 10 times less carbon intensive. But the real appeal may be that the material is faux, durable — and luxurious. Demand from Hermes and other high-end designers, whose clients are turning away from leather just as they did years ago with fur, has grown, and Conway feels that the alternative leather could also be used in the auto industry, where BlackRock as a whole has $100 billion of investments for clients. Through its Decarbonization Partners fund, BlackRock Alternatives ultimately participated in a $125 million investment in MycoWorks, money that will help the company build its first full-scale production plant.
After years of sky-high valuations, companies like MycoWorks are finally available at much better prices. Conway says that late-stage venture is one area in alternatives that has repriced, with founders and management teams coming around to the idea that the economy and interest-rate environment are far different than they were even a year ago, and that they need to adjust to attract equity capital. BlackRock Alternatives has participated in other investments in smaller technology companies, including in Group14 Technologies, which helps improve the lithium batteries necessary for electric vehicles.
Unlike listed stocks and public fixed income, alternatives are only priced quarterly. Conway says that the repricings — the updated valuations — have been uneven across the industry. As a result, investor dollars are headed in different directions. “I would call it a recalibration in private equity,” he says. “I do think in private equity, you’ve absolutely seen a shift in sentiment, particularly in the larger end of the market. Valuations are remaining very strong,” said Conway.
But late-stage venture capital companies like MycoWorks and early-stage growth equity have adjusted. “The investment opportunity set for us has really picked up,” says Conway. BlackRock Alternatives, which has $313 billion in assets, is avoiding the larger end of the private equity market, watching for the repricing to come, and is favoring PE secondaries.
According to the firm’s outlook for 2023, the asset manager also expects that lower average purchase-price multiples will allow its portfolio companies to make more acquisitions to drive growth and achieve scale. It also anticipates that as management teams focus on their core strengths, the number of public companies that will be taken private and the number of corporate carve-out deals that will be completed will increase.
Not surprisingly, BlackRock says that private equity buyers are rethinking how they determine risks and structure deals. “More general partners are building buffers into the capital stack as negotiating leverage increasingly shifts away from companies toward investors,” wrote the authors of the outlook.
When it comes to real estate, BlackRock has been defensive in recent years, tilting to areas like logistics that supported the huge rise in e-commerce, but it’s now optimistic about certain sectors that remain controversial, such as commercial office space. With a big slice of employees still working at home at least part of the week, companies have downsized and renegotiated leases, putting enormous pressure on the sector.
But Conway believes that the relationship that companies have with the office is normalizing. Businesses are realizing the value that offices provide when it comes to bringing talent together and building company culture. (BlackRock CEO Larry Fink is big proponent of getting workers in general back to the office, with the company’s own employees required to be in the office at least three days a week.)
“Prime office space is back,” Conway says, but he adds that he’s “waiting a while before deploying capital.”
Overall, the alternatives manager favors real estate debt over equity (although Conway said that equity has begun to look increasingly attractive) and is keeping an eye on supply-constrained areas such multi-family, which the firm feels is a necessity now, given the high cost of single-family homes.
According to the report, Europe looks a little different. “The real estate market is working through a price-discovery phase, as wide bid-ask spreads and rising financing costs limit liquidity,” the authors wrote. But values are mostly declining, particularly in the U.K.
BlackRock clients are favoring infrastructure and private credit, in particular. Conway argues that the slowdown in initial public offerings illustrates the importance of private financings. Management teams are questioning not only when they should go public but if they should go public at all. “The available tool kit that you have now as a private enterprise is very high. The asset management industry has become the lender of choice,” he says.
That doesn’t mean it’s all rosy. Some industries may fare better than others, Healthcare, software and technology are among those that can pass on higher costs from inflation to their customers. But “Some business models may not financially work at a higher cost of capital,” according to the report.
Private credit has also opened up new options for companies that don’t want to dilute their equity. Investors can offer financing and get some equity participation.
But persistent inflation and other macro factors are making alternative investments even more heterogeneous. “Each and every asset class within alternatives will have very different outcomes, and the timing of those outcomes will be different,” says Conway.