Just like most of the economics questions: it depends. On the sector, the diversification of your portfolio, your return projections, and if you run solo or with a fund.
However, experts agree that it’s safe to say projected inflation rates shouldn’t have a noticeable effect on PE and that the healthcare industry appears as one of the best-positioned in the midst of current economic uncertainty.
Inflation in 2021: General Context
In 2021, inflation numbers became a predominant conversation topic on almost every table, barbershop, and supermarket line in the United States. Even Google confirmed it: last year, inflation-related searches were higher than ever.
And how wouldn’t it? The inflation figures have soared at a surprisingly high pace. Even though the Federal Reserve assured early last year that it was a “transitory” phenomenon, the prices didn’t stop hiking up, hitting the highest point in nearly four decades (6.8% in November).
Economists and financial experts foresee that inflation will be sticking around for at least the first quarter of 2022 and won’t be returning to “normal” levels until late this year. Naturally, Americans worry about their purchasing power and ability to protect their investments.
So… how does this inflationary environment play out for venture capitalists and private equity investors?
The market consensus is that the projected inflation range shouldn’t have a noticeable effect on PE (so you can sigh in relief). Companies backed by private equities have proven to be more resilient than their public counterparts during turbulent economic periods, according to a Cambridge study following the 10 years after the 2008 global recession.
Furthermore, the private asset class is slow in reacting to economic fluctuations, sometimes taking half of the time to perceive the effects seen in the public market.
If you are an investor whose gross capital is placed on short-term investments, the key concern is how much your return margin will be constrained by inflation (real return). On the other hand, long-term investments are more likely to be unaffected as they usually have longer hold periods and can grant you more time while the economy stabilizes before exit.
The business model could be the difference between successfully managing adverse scenarios or being severely affected by market gyrations. If you are looking to invest during an inflationary period, focus on trusted organizations with a proven track record of prior success in similar economic contexts.
How does inflation affect different markets in private equity investments?
Another key factor when measuring the impact of inflation rates is the industry – some are more vulnerable and others more resilient. One of the reasons inflation turned into a headline issue is the sudden imbalance between supply and demand among specific sectors of the economy (in this case, the energy industry is the most affected).
While automobile manufacturing and energy commodities have been deeply hurt by inflation, sectors such as tech and healthcare look promising —given the current pandemic, medical advancements are encouraged more than ever in all areas of the healthcare industry.
Yet, in the end, it all comes down to one word: innovation, the antidote to all inflationary pressures. This is best summed up in a quote from Michael Sonnenfeldt, Tiger 21 founder and president, in which he compares inflation and innovation to two competing trains:
“One is the inflation train and it’s already picking up speed, so for other train, call it the innovation train, to go faster it will need some amazing themes and success. And the faster the inflation train goes, the harder you have to push the innovation train to get past it. But inflation doesn’t preclude innovation from creating new industries and products.”
- Strategic investments in private equity and venture capital provide a certain shield against market gyrations.
- Invest in companies with solid cash flow and backed up by good management with a proven success record.
- Long-term investments allow you to handle transitory situations better, giving you time to turn around economic instability.
- Don’t put your eggs in one basket: keeping a diversified portfolio is one of the best ways to protect your investments.
- Keep an eye on other external factors: the implications they might have on the industries you are investing in could be even more significant than inflation rates themselves.
- Bet on innovation: investing in disruptive products that could translate into high-yield opportunities is the best way to neutralize the effects of growing inflation.
Adams, S. (2021). Venture vs. Inflation – Growth is Paramount. LinkedIn. [December 8]. [Online]. Available at: https://www.linkedin.com/pulse/venture-vs-inflation-growth-paramount-sarah-adams-anderson/
Google Trends. (2021). [December 20]. [Online]. Available at: https://trends.google.com/trends/explore?date=today%201-m&geo=US&q=inflation
Patton, M. (2021). Investing In Today’s Inflationary Environment: What Investors Need To Know. Forbes. [June 23]. [Online]. Available at: https://www.forbes.com/sites/mikepatton/2021/06/23/investing-in-todays-inflationary-environment-what-investors-need-to-know/?sh=47da8605bfb1
Rosenbaum, E. (2021). How inflation is changing the way wealthy investors think about the market. CNBC. [November 2]. [Online]. Available at: https://www.cnbc.com/2021/11/02/for-first-time-since-covid-bear-market-wealthy-expect-stocks-to-drop.html
Routley, N. (2021). U.S. Inflation: Which Categories Have Been Hit the Hardest? Visual Capitalist. [November 19]. [Online]. Available at: https://www.visualcapitalist.com/u-s-inflation-which-categories-have-been-hit-the-hardest/
Tiger21. (2021). Innovation vs. Inflation | CNBC Interviews TIGER 21 Founder. [November 2]. [Online]. Available at: https://tiger21.com/insights/innovation-vs-inflation/
US Bank. (2021). Effects of inflation on investments. [August 6]. [Online]. Available at: https://www.usbank.com/financialiq/invest-your-money/investment-strategies/effects-of-inflation-on-investments.html
US Bank. (2021). How will inflation impact investors in 2022? [December 13]. [Online]. Available at: https://www.usbank.com/investing/financial-perspectives/investing-insights/how-does-inflation-affect-investments.html
White, C. (2021). Why inflation has limited impact on healthcare trends. Milliman. [September 27]. [Online]. Available at: https://www.milliman.com/en/insight/why-inflation-has-limited-impact-on-healthcare-trends#5