Market illiquidity, a greater risk of policy errors by the world’s central bankers and a peak in corporate margins could nix opportunities in private equity markets.
MLC CIO Jonathan Armitage sounded this warning at a conference held by the Australian Investment Council – formerly Australian Private Equity and Venture Capital Association (AVCAL).
At the conference, Armitage drew attention to the changing liquidity environment, saying that after a decade of monetary stimulus across the globe it was clear the capital draining from the financial system would drive increased volatility.
“We are already starting to see these dynamics play out and they goes some way to explain the volatility we saw in public markets late last year,” he said.
Investors unable to predict capital flows remains troublesome according to Armitage.
“Our expectations are that this will continue to play out for some time to come and this very significant implications not just in terms of funding but also the dynamics that we see playing in capital markets over the next few years,” he said.
Armitage said liquidity was “ephemeral” in number of different markets and he called this situation a profound change. “It’s there until it isn’t –and that has implications for all of us whichever parts of the capital markets we operate in.”
Risk in developed markets
The investment chief also warned that developed economies had reached the point in the economic cycle where the risk of a policy mistake is becoming greater.
At one level Armitage argued this could be a simply a central bank hiking interest rates faster than underlying economy can stand.
“The other way this could other way this can manifest itself is through a series of what might appear at first sight to be unrelated policy decisions but which have much wider ramifications than originally intended.
In his view, this could significantly increase the possibility of an adverse outcome and he cited the trade wars and increasingly populist stances taken by developed economy governments as examples.
“These are very much focussed short-term term outcomes and the long-term ramification tend not to not well understood by politicians who follow short-term economic cycles.
Finally, Armitage urged investors to analyse corporate margins which are close to, or are at, an all-time high through a combination of structural and cyclical changes.
He pointed to lower US taxes and technological transformation as being structural changes as opposed to higher company capital expenditure programs, higher gearing practices and robust economic growth, particularly in the US, which are cyclical.
The sustainability of these margins is a key focus for Armitage but he warned that investors may be mixing up the cyclical and the structural elements.
“Certainly, past history would suggest investors are not good at looking at these inflexion points and seeing how they feed into cash flow and corporate earnings.”
“Obviously this is a dynamic that is important across all parts of the capital structure and all parts of the market.”