Tawfik Hammoud is the global head of BCG's Principal Investors & Private Equity practice and is based in Toronto. Vinay Shandal is a partner and managing director in BCG's Toronto office.
When you look at who attended last week's World Economic Forum in Davos, it's striking how many are global investors or work for large funds – and in particular, private-equity firms.
The question Canadians should be asking themselves is, how do we ensure that Canada receives its fair share of the trillions of dollars deployed by global investment funds, including real estate, infrastructure, venture capital and private equity? How can our entrepreneurs and company owners benefit from this growth capital and the opportunities that come with it?
How can we create an investment ecosystem that gives rise to more Canadian investment firms led by top professionals?
The global investors who gathered in Davos, Switzerland, have much to be thankful for. Business is thriving and the various private asset classes' performance keeps pumping up demand, especially relative to fixed income and public equities. Take private equity, for example: 94 per cent of investors in a recent survey count themselves satisfied with the returns, and more than 85 per cent say they intend to commit more or the same amount of capital to private equity next year. As a result, the capital flowing into private equity is unprecedented, established firms are raising record amounts of money and fund oversubscription is common.
More than 600 new private-equity funds were created last year alone and the industry is holding $1.3-trillion (U.S.) of "dry powder," or uninvested capital, that is sitting on the sidelines waiting to be invested. While the merits and operating model of private equity can and should be debated (as they were when former private-equity man Mitt Romney ran for president in the 2012 U.S. election), there is no denying its growing importance in many economies. Carlyle Group and Kohlberg Kravis Roberts & Co. (and their portfolio companies) employ more people than any other U.S. public company outside of Wal-Mart Stores Inc.
The sector's roaring success might also be the biggest risk to its future. There might be such a thing as too much money, after all.
A swath of new entrants is pouring into private assets, searching for yield in a world of low interest rates. Chinese, Middle Eastern and other emerging markets investors are on the rise and have quadrupled their outbound investment over the past few years. Sovereign wealth funds, pension plans, insurance companies and even some mutual funds are allocating money to the private markets and borrowing from their playbooks. So much money chasing a limited number of opportunities has pushed prices up: historically high multiples combined with lower levels of leverage are putting pressure on returns. Private-equity deal multiples, for example, have exceeded the peaks last seen in 2006-07 for larger transactions (deals above $500-million) and deals above $250-million are also flirting with these highs. But most indicators still point to a favourable outlook as long as the credit markets remain fluid and fund managers continue to create value during their ownership period.
Canadian pension funds, many of which were present at Davos, are increasingly active in this crowded field. They have invested time and money to develop direct capabilities and increasingly stronger investment teams. In many regards, they are years ahead of their peers around the world. However, outside of our pension funds and a few select local firms, Canada tends to punch under its weight. We lack the kind of developed investment ecosystems that are thriving in other countries. As an example, the United States has 24 times more private-equity funds than Canada and has raised nearly 40 times more capital over the past 10 years.
The point is broader: Canada should be attracting more foreign direct investment, including money from global investment firms. FDI in Canada has grown by just 2 per cent a year since 2005, compared with an average of 7 per cent for all OECD countries and 8 per cent for Australia. As a percentage of GDP, Canada still sits in the middle of pack of OECD countries, but 30 per cent of that investment is driven by mining and oil and gas and is heavily skewed to M&A as opposed to greenfield investment (relative to other countries).
Something doesn't add up. Canada is a great place to put money to work. We are a country with low political risk, competitive corporate taxes, an educated and diverse labour force, liquid public markets and a real need for infrastructure investments. Yet, we are net exporters of capital: foreign investors are often not finding Canadian opportunities as attractive as they should.
For all the criticism the investment industry sometimes faces, it would be a real miss if we failed to show long-term, growth-minded investors that Canada is an attractive place to put their money to work. We want global investors writing cheques for stakes in Canadian companies, so they can help improve their productivity, invest in technology, create new jobs, and grow global champions in many industries. If investors don't hear our compelling story, Canada and many of its companies could be left on the sidelines as they watch all this dry powder get deployed in other markets.