How much of a concern are rising interest rates at the moment and how are you addressing the challenge?
Leverage is more moderate in the mid-market than it is in the large LBO space, but interest rates are an important consideration, nonetheless. We have been in a near-zero rate environment for a long time, so this isn’t something we have had to manage for the past decade. We are looking at interest rate caps and floating to fixed-rate swaps. We haven’t pulled the trigger on any of those things yet as it is still quite expensive in the market, but there is certainly additional analysis going on that hasn’t taken place in quite a while.
What about the impact of inflation, and particularly wage inflation?
Inflation if just driven by rising wages can be good, but we are seeing broad based inflation triggers. It is definitely something that we are monitoring and see as an increased risk, particularly when fixed-term contracts are involved.
Against this volatile backdrop, what operational levers do you consider to be most important to the success of a portfolio company?
The pandemic – and now war in Ukraine – have emphasized the importance of the resilience of supply chains. We went through two decades of just-in-time production and the expansion of overseas sourcing. But those two things combined, as we have seen, can create a pretty fragile situation. As a result, we have a number of portfolio companies that are onshoring sourcing capabilities.
The other vital operational lever that we possess is talent acquisition and retention. Disruption in the workforce is extremely expensive and so it is well worth our while spending time ensuring our employees feel part of our portfolio companies and want to stay. Those dynamics are intensified today, because the talent market is so tight.
Presumably cost management and pricing strategies are also proving increasingly important, given rising inflation?
Cost management is always important, but I think about it primarily in terms of proactive strategies, such as successful recruitment and retention campaigns, rather than efforts to keep wages down. The frictional costs associated with poor hiring or having positions open for too long are what we look to control. And when it comes to pricing strategies, of course, it is about an understanding of who is going to bear the increased costs that are coming through.
How is the role of ESG evolving as an operational lever?
For us, ESG strategies are not just about mitigating risk but also expanding opportunities. The value we get at exit is enhanced by ESG measures that make our companies more resilient and sustainable.
The US, in general, has been a bit slower than other regions when it comes to understanding how ESG can be a driver of value for private equity and the focus has primarily been on governance, of course, and more recently environmental considerations. Where I think we will see a lot more focus going forward is on the social side of things. It is time to catch up on issues of human capital.