In the realm of private equity, a robust risk management framework can deliver less volatile, higher-quality performance results over time.
Private equity (PE) managers have traditionally been very total return-focused, seeking to drive returns through high leverage levels, aggressive business plans and cost cutting. The strong equity market environment of the past decade has only sharpened that focus, as lofty returns have often been required to beat public market equivalent (PME) benchmarks.
Rarely, however, do PE managers and investors talk at length about what risk was taken to achieve those returns. That is an unfortunate missed opportunity and demonstrates that private equity markets are still in the maturation phase of their institutionalization lifecycle.
Risk and return go hand in hand for all investments. A successful risk management framework can deliver more durable, less volatile and higher-quality performance results over time.
For limited partners (LPs), the solution has been straightforward: mitigate downside risk through diversification. But as LPs concentrate their portfolios and narrow their relationships to fewer, larger general partners (GPs), the risks they face are changing. Meanwhile, regulation, high prices, ESG and other factors are fueling an evolution in how GPs address risk management. These trends are likely to persist as the PE business continues to develop.
At Barings, we have been intently focused on risk management for the entire history of our PE and real assets business—and our risk management philosophy has remained largely unchanged during that time.