Scenario Analysis | A Private Investor’s Perspective on the Opportunities & Challenges

Share This Podcast

Share on facebook
Share on linkedin
Share on twitter
Share on email

Listen & Subscribe On: Apple Podcasts | Spotify

Learn More About Mercatus Here

Robert Wall has over 20 years of experience growing private market investment portfolios, investing in infrastructure companies, and delivering major engineering projects.

His experience as a GP, a direct investor, and a LP brings a broad perspective to the discussion of how investment management is evolving. To read the transcript of this episode below and be sure to sign up for our Mercatus Digest newsletter to stay up to date on the latest insights and updates in the private markets. Click that follow button and leave us a review on iTunes, we’d love to hear from you. To further discussion, reach out to Kali Jakobi directly at [email protected]

Transcript:

Kali Jakobi:

Welcome back to this episode of Data Disruption by Mercatus. I’m your host Kali Jakobi. And today I’m joined by Robert Wall, discussing opportunities and challenges of scenario analysis. Robert has over 20 years of experience growing private market investment portfolios, investing in infrastructure companies and delivering major engineering projects. Most recently, he was a partner and member of the investment committee at Hermes infrastructure. Prior to this, Robert worked at Canada Pension Plan Investment, executing direct infrastructure investments in developed and emerging markets. His experience as a GP, a direct investor, and an LP brings a broad perspective to the discussion of how investment management is evolving. Without further ado, Robert, thank you so much for joining me.

Robert Wall:

Thanks Kali. I’m excited to be speaking with you today. At the outset, let me say, I believe that technology, data and private capital have important roles in infrastructure investing. And when applied correctly, these three factors can improve livelihoods, promote low carbon economic development, mitigate the impacts of climate change and make societies more resilient. I think the context for our discussion is the axiom that the past 12 months have shown the importance of assessing potential financial and non-financial events.

Kali Jakobi:

Robert, before we dive into the opportunities and challenges, can you first provide context for why scenario analysis is so important to the role of investment manager?

Robert Wall:

Sure. Well from 30,000 feet, the job of investment management is simple. We match capital with investment opportunity. The manager, they need to identify what limited partners or clients are seeking to achieve, and then undertake a diversified set of investments, finally managing and monitoring and reporting. That in reality, this is made much more complex by archaic information, volatile markets, exogenous events, competition, and then of course in private markets, holding illiquid positions. So really, let’s consider the different perspectives of the underlying investors. You’ve got LPs and pools of capital, and then managers, GPs or direct investors. The LPs need clarity ultimately. They want to know how their managers are going to deliver on target returns, how they’re going to assist the impact of changing market conditions. And they want to be able to take forecasts from many different sources and managers to assist the impact of their overall fund or pension scheme.

Robert Wall:

But mostly they just hate surprises. GPs on the other hand and private markets, they’re building and managing a diversified portfolio of long-term investments, constantly working to ensure there’s deliver on the targeted outcomes as events unfold and as new information comes to hand.

Kali Jakobi:

Robert, I like how you mentioned the different perspectives of the LP versus the GP. Talk to me about how the current way of doing scenario analysis plays out for each of those roles.

Robert Wall:

I think it’s important to note at this point, there’s really a broad range of capabilities. And then also the importance why different LPs, direct investors and GPs varies for this type of forward-looking analysis. So as always, it’s dangerous to generalize, but with that caveat, let me generalize a little. GPs and direct investors, they’re running highly detailed, complex financial models to complete due diligence of companies they’re seeking to acquire. These Excel models, they are then used to support ongoing management of the investments, which provides the opportunity to fine tune, forecast, change various operational and financial assumptions, and do that over time for individual investments, which works well.

Robert Wall:

However, the complexity really comes when you attempt to run a scenario across a portfolio of investments. Each with different model structures, each run by different individuals within the team. Inputs and outputs vary, there’s inconsistency. And let’s remember the goal here is to have a diversified set of investments and test what might happen in the future. So we end up with results from multiple Excel models being used to feed into one central, call it a fund model, to then assess changes in inflation, interest rates, GDP forecast, et cetera. The position of the LPs slightly different again, but they have less data, they’ve no forward-looking information. And so they’re relying more or less on implied correlations, which is the age old driving forwards in the car while looking in the rear view mirror.

Kali Jakobi:

Seems like a precarious situation to say the least. Now take me through the opportunity here at hand for private investors.

Kali Jakobi:

Tell me what you’re really seeing.

Robert Wall:

Great. Yeah. We’ve always known that private investors have access to interesting data, trends across the portfolio, screening of new markets for investments, macro and micro factors. We never had the ability to capture this information. Really, it relied on talented individuals picking up, identifying, spotting something of interest. And let’s be honest, many investment managers are just using Excel, PowerPoint and Outlook. So what I’ve seen recently, and it has a lot of power, is that the right software and a technology partner can now enable us to ingest data directly from PDFs, from XLSXs, real life files that are being exchanged between operating companies and investors, which is for sure the tipping point in capturing this data.

Robert Wall:

Clearly this applies to financial information, but the opportunity extends to non-financial too in my mind. And to put context on that last point, [inaudible 00:05:59] noted this week that 66% of GPs have cited the lack of high quality consistent data as their top challenge in implementing [inaudible 00:00:06:08] strategies. And Larry Fink’s 2021 letter to public companies is very clear on the importance of data, in particular, the benefits of coherent and consistent reporting. And one part stood out to me in that, and that’s, within the last 12 months, 1700 organizations have expressed support for the TCFD, and that’s the Task Force on Climate-related Financial Disclosures. So this drive for non-financial information is really picking up speed.

Kali Jakobi:

That’s interesting, Robert. And I totally agree with you that the right software and technology partner makes all the difference. The idea that businesses can continue to operate with their data and Excel is a bit archaic and quite honestly, seems risky. We know adopting technology and finding the right data management partner is crucial to the success of an investor, but let’s unpack how the data ties in and really supports scenario analysis.

Robert Wall:

Sure. Scenario analysis is really just being central to undertaking private investments as long as I’ve been involved in them. It’s the main part of what we do. We’re trying to predict the future based on information, due diligence findings and insights we gather. And if I think back to the financial crisis, it was very unclear how interest rates, inflation and GDP would interact and evolve. More recently over the past year, the C 19 pandemic is just further showing that considerations around changes in travel patterns, consumption, population forecasts, they’re all varying too. So you overlay these multiple factors on top of a portfolio of 10 plus assets, and suddenly you understand the challenge of scenario analysis. If we wind back to my comments on the job of the GP, the investment committee needs to be able to consider what risks to add or reduce to its portfolio.

Robert Wall:

That constantly looking to refine the investment strategy, the assets, the attention and resources being applied through the management teams and considering whether or not the next deal should have more or less exposure to inflation, fixed interest rates, international travel. And so scenario analysis across an existing portfolio is critical, and as we evaluate the next investment. I’ve got to say, all managers are doing this, but with a certain level of embedded inefficiency and potential inaccuracies. Assunta Gaglione-Austin said on one of your earlier episodes, he had this great quote, “Are we making decisions based on good data or not?” I think it really is that simple.

Kali Jakobi:

And I’m sure that’s a question that keeps many executives up at night. So tell me, Robert, how should people start navigating this process?

Robert Wall:

Good news is that it’s not a change of culture. And I’m not an expert on software implementation. I’m not an expert on change management, but what I can clearly see are three important steps. Step one, let’s use technology to more accurately and more quickly onboard the data that is already available to us as managers. For example, let’s get some software that can adjust PDFs. Step two, let’s move away from the analysis of individual investments and take steps towards a flexible centralized platform that analyzes one version of the truth across your whole portfolio. Almost certainly that’s not Excel based. And then finally, step three, let’s overlay better swifter analysis to improve their decision-making around investments and to take a step forward in improving the reporting for our investors. I think it’s clearly an investment of time and money to make this transition, but there are immediate opportunities to free up time for the talented analysts that work in the team, and also the improvement in the analysis that’s being done quicker.

Robert Wall:

So the team’s no longer spending days entering data, they’re not running different financial models, they’re not reconciling outputs. And then it doesn’t take much to see how managers that can trust and analyze the data can make swifter and more definitive decisions on how individual assets might respond on the various events, which makes us better managers, better informed around how we take decisions around financial leverage, how we improve the forecast performance and how we optimize a portfolio through buying and selling companies that might respond differently under various scenarios. Then I look to the future, and this is where it gets really interesting.

Robert Wall:

First, we’re going to need to expand scenario analysis to cover metrics of sustainability. What is the impact of a carbon tax on the portfolio? Lots of people are asking us, “When, or how will our portfolio be carbon neutral? Is resource, for example, water consumption, increasing, or decreasing?” And then the second big opportunity is how you use this improved forward-looking analysis to improve investor reporting. I think everyone agrees. Monthly and quarterly reports from GPs to LPs are not particularly useful. But what if these reports included greater information on the portfolio under certain assumptions? How about if LPs could use these reports to conduct their own financial carbon sustainability analysis across their full scheme?

Kali Jakobi:

Robert, I appreciate the way that you gave us practical steps of what they can do next, but also building a vision for what the future could be. There seems to be quite the opportunity at hand here quickly to improve reporting. I’m curious, on average, how long does it take to create those monthly and quarterly reports for a business operating largely out of Excel?

Robert Wall:

Yeah, well too long and with too much cross-checking. I guess it’s hard to be precise. More interestingly, the time it’s taking is getting longer with each year, and as complexity of the portfolio increases. But perhaps also, importantly to note because investors want more information, they’re asking more questions. So managers not only have to find a more efficient way to do this, but they also need to find a way that does that as accurately as possible, and in a way that provides more interesting information.

Kali Jakobi:

If we’ve learned anything from the past year, complexities are only going to keep growing no matter what they look like. Now, as we look to the future of investment data management, how do you see scenario analysis evolving to shape the winners and the losers in this space?

Robert Wall:

I believe, private markets will start to converge with the liquid public market investing. As data becomes ubiquitous, then there’ll be winners and they’ll be the ones that recognize that by capturing better data, you can use it to run more dynamic investment portfolio. Artificial intelligence is the other piece here. Already, AI has been used to screen markets for private investment opportunities more effectively than teams of individuals sitting in front of Google. So with the right data hygiene and clear parameters, using the existing businesses that are owned, surely we can use pretty basic AI tools to identify a more optimum portfolio. And thinking about COVID-19 and the global financial crisis, we can see that even broad portfolios of private assets can be exposed to systemic risks. Ultimately, a lack of diversification or over leverage are the most common causes for GPs failing. Scenario analysis is a way to ensure that both of these risks are understood and managed. I’ll leave the listeners with one question. How can managers make their reporting useful and reliable, particularly as the technology exists to bring in data and to swiftly conduct scenario analysis?

Kali Jakobi:

That’s a great question to leave us with Robert. Useful and reliable reports are certainly key to success in this business, but being able to look ahead and plan for the unexpected is a real competitive advantage. And Robert, you know I’d be remiss if I didn’t add in a shameless plug here from Mercatus, because you’re right, the technology does exist as right here and we are ready to take on any bespoke needs clients can bring our way because of the flexibility we bring to the table. So talk to us about scenario analysis, request a demo on our website, or even reach out to me directly. I’ll leave my email in the podcast description. But most of all, Robert, thank you so much for joining me today. Your expertise and unique perspective has provided so much value. If people would like to continue this conversation with you directly, what’s the best way for them to get in touch?

Robert Wall:

Connect with me over LinkedIn. I’d be happy to continue this discussion.

Kali Jakobi:

Awesome. Thanks again, Robert. It’s been a pleasure.

Robert Wall:

Thanks Kali. I wish you and your listeners all the best.

Kali Jakobi:

Thanks for listening to this episode of Data Disruption by Mercatus. If you like what you heard, share and leave us a review, it helps others discover the show, and I thank you for it. And if you’d like additional insights related to this conversation, go to our website at gomercatus.com/resources.

 

More Podcasts from Mercatus

Change on the Horizon: Diversity within Asset Management

Paul Greenwood, CEO and CIO of Pacific Current Group, joins to discuss an article he published in Pension & Investments called “Commentary: Improving manager diversity demands that shortcuts stop.” On this episode, he breaks down the decades-old rules of thumb that need to change in order to diversify manager selection and increase overall performance.

Sign Up for the Mercatus Newsletter

The Mercatus Digest provides private market news and insights with an emphasis on the current change we are all undergoing; the shift to data-driven business intelligence.