Partners Group Holding AG (PGHN) Earnings Call Transcript & Summary

Good morning, America, and good afternoon to those joining us from Europe and welcome to Partners Group's Private Markets Outlook webinar. My name is Georgina Wood, Client Engagement Manager, and I'll be moderating this session for you today. I'm joined live from our offices in Zug by our Chief Investment Officer, Stephan Schali, and our Senior Economist, Tina Jessop, as well as a number of senior colleagues from our investment teams. Today, we'll be presenting you with our outlook for private markets, as well as our outlook on our 4 private markets asset classes. Most importantly, though, we want to use this session to answer your questions on private markets. Many of you have submitted questions in advance of the webinar and we encourage you to continue doing so throughout the webinar by clicking on the submit a question box that you can find on the lefthand side of your live stream. We'll be kicking off this session with our CIO and macroeconomic outlook. So please feel free to start submitting questions on these topics and we'll then move on to our individual asset classes. And before we start, I would just like to highlight that this is an event intended for institutional investors and not for the general public.

So, Tina, if we can start off perhaps a little bit by setting the scene on the macro side. What would you say is our current outlook for the economy and how does that compare to what we predicted a year ago? What did we get right and what did we get wrong?

Yes. Sure. So I think when we make these assessments, it's important to highlight that given our long-term investment horizon, we make economic projections for the next 5 years. And then, of course, we divide that into a more near-term cyclical outlook complemented then by a structural outlook. And many of the structural trends that we have highlighted over the past 1 or 2 years are still unfolding. We're in a new interest rate regime, and the market has come around to our view that rates are going to be higher for longer. Also, there is greater acceptance that inflation rates may trend more than the 3% to 3.5% range as opposed to the 2% that central banks are targeting. Partially, this is driven by geopolitical tensions. We have still ongoing tensions between the U.S. and China and Russia and now sadly also in the Middle East, we have intensifying tensions. And this will continue to impact supply chain and energy and security consideration and also ties in with our view that fiscal deficits are going to be higher. On a positive note, what we have seen is an acceleration in the AI revolution, and this makes midterm lift to productivity rates more tangible. From a cyclical perspective, we were right to assume that rates would continue rising. Headline inflation came down a bit faster than we'd anticipated, but we were right to say that core inflation would be slower to decelerate given tight labor markets. On the growth side, I think the U.S. has surprised quite positively. Europe is already stagnating. We had a recession penciled in for the second half of this year. We still think that tighter financial conditions and diminishing pandemic savings are going to weigh on growth going forward. And then for rates, this means that unless we see a deeper recession they're going to stay at current levels until the middle of next year before then leveling off in the 3% to 4% range. So in a nutshell, we have this J-curve analogy whereby we think that over the near term cyclical weakness prevails, but then in the mid to longer term we're going to see a boost from technological advances.

Great. Thanks, Tina. And Stephan, Tina has obviously just described the rather complex macroeconomic backdrop and this higher for longer interest rates environment. So how is this impacting private markets and Partners Group's investment approach in this environment?

Yes. Thanks very much Georgina. I'd like to answer the question by focusing on the buyout private equity markets. Clearly, the main impact I see is on the financing market. It's less credit available. Credit is more costly. Typical debt packages cost about 2x as much as back in the '21. So that's one impact. But the other impact is also new transactions because you have less debt available, the prices are lower. Not everybody in the market is ready as a seller to accept this lower pricing. And so there is a bit of a bid and ask spread and a slowdown in the transaction volume that we have observed. The other part is also the lower economic growth has an impact on assets because many of the companies and assets face a bit lower demand. There is a slowdown in demand, especially in Europe. I would say, private market assets in general, if you look back 20 years, have actually weathered the storm or such a period fairly well. They're most nimble. They're very agile to act with the right driven management and the right boards. The other part, and that's the second part, is on the investment approach. How do we change? How do we adapt here? We invest generally as Partners Group in companies that are well equipped to weather the storm. They are high-quality companies and can master the complex environment. At the start, we invest thematically. We invest in industries that have a long-term structural growth embedded, so sectors that can profit from structural trends and we invest in established businesses. Also, the higher for longer that you just talked about on the interest rate side, clearly requires today a focus on value creation. Gone are the days when you can just with financial engineering invest in assets and take advantage. Today, it's all about transformation, buy and build better. The other part is on the underwriting side. When we buy new assets, we look that we keep the scenarios that you talked about here, the recession case, stock price, all these cases into our minds and see whether those assets that we buy could handle them. So you have a certain protection here also on the downside. Last, in terms of financing, we have proactively refinanced 90% of the debt packages of our companies already over the past 2, 3 years and the first majorities are beyond '25. So we have a long term security. It all sounds a bit negative, of course. These topics that we discussed today, but let me be assured, private markets often have done best in periods such as today where you can buy at reasonable prices and then invest for the long-term.

Thank you, Stephan. And you mentioned just now a recession scenario in your remarks and this is also a question we got from clients in advance of the webinar. So maybe Tina I'll put this to you, how well positioned is the portfolio to withstand a recession scenario?

So if you're in a period of lower growth and higher inflation rates, really what you look for in a portfolio is demand resilience, margin stability and then also a degree of diversification. And as Stephan has just explained, we -- or our investment approach is centered around the thematic approach. We focus on value creation at the asset level, and we invest in companies or in assets with a strong market position. So this means that the assets and the sectors that we invest in typically generate above average EBITDA growth, largely irrespective of the macroeconomic developments. And it also the strong market position gives them pricing power and the power to negotiate with suppliers or the flexibility to adapt to a changing environment. So, it has worked well. So, over the past 3 years, we have seen inflation rates reach nearly double-digit numbers. However, in our private equity directs portfolio we have seen successful passing on of f-rising prices EBITDA margins have remained constant just shy of 20% and EBITDA growth has remained attractive. However, having said this, we're not completely isolated from economic developments. If we take the German toy industry, for example, because of a post-pandemic building up of excess inventory, we have seen revenues contracting over the past month and one of our portfolio companies in this environment and was not able to pass on rising prices and they have seen margin contraction. So this is then where the diversification aspect comes in and we place great emphasis on regional and sectoral diversification across all asset classes.

And Stephan, we also had quite a few questions in advance of the webinar on valuations. How do you see valuations involving in this environment? Have we seen the full impact from higher rates on valuations and what's your outlook for next year?

Yes. Good question. I think 2 parts of the question, first of all, what are entry valuations and second part, what are valuations for existing portfolios. On the entry valuation side, if you look, for example, on the buyout side, new transactions, those transactions were on average about 15% lower in the first half of 2023. So there is a slowdown across the industry. On our side, on our end, we have not seen quite such a transaction. We focus on high-quality middle market assets, and there is of course quality pays off less correction. There is also a certain bifurcation that we observe. So across industries, across sectors, we have seen the most corrections on healthcare and technology, those sectors, maybe also a bit alongside the public stock markets and lesser corrections, for example, in the service industry where there was much more resilience. Now if you look on portfolios as such, for existing portfolios, we have adjusted those ourselves lower in '22, took valuations down, also based on comparables. And in the first half of '23, those valuations recovered by about 8%, again, comparables had an impact, but also further value creation. What we observe, however, in the industries, not everybody, not all the general partners have this approach of fair valuation, but many keep the valuation surprisingly at the high level. This means if a sale process eventually comes, there's a surprise on the seller side that valuations will be negotiated down subsequently in the process. And forward looking, that's also you asked what's our outlook for '24. We think, yes, there has been a first valuation round done to the downside. There is still a bit more to come. These processes take a bit of time, but it's also healthy for our industry. And bear in mind when we talk about valuations for next half year, for 1 year out, this is a long-term asset class. So when you invest here, whether the temporary valuation was a bit higher or lower, this does not matter as much for the long-term result.

And we've had actually a live audience question come in from an investor based in France who's actually asking about relative value over time, so kind of short term, midterm. Long term, how would you prioritize investments across Partners Groups for asset classes?

I believe it's a relative value can be across the asset classes. So private equity, debt, real estate, and infrastructure. And clearly, at the moment, resilient infrastructure investing, but also debt investing has a bit higher relative value above private equity and real estate. And clearly, debt is a good example. You have higher rates, you have higher margins. Debt lenders again have a more, an upper hand and they can negotiate better. So that changes a bit the relative value. But there's also a relative value within the asset classes. If you think, for example, private equity, you can invest in direct investments, you can invest in funds, you can invest in secondaries, you can invest in different sectors. For example, the secondary market is quite attractive in private equity. You see a lot of dislocation. Sellers that have less liquidity in their portfolios go to the secondary market and offload part of their portfolio. That's also the strength of the asset class that you have a functioning secondary market. And of course, as a buyer, it's a good moment to buy in times when there are more sellers.

And actually, on that note, you said time when there are more sellers, could you comment as well on the exit market and what we see there? What exit opportunities you see across the portfolio? In general, what's your view on how the exit market might evolve?

So overall, I believe the exit market is a window that is sometimes open and closed. And I would say we have a less favorable exiting window right now. But the strengths of the asset class in private market is that you can choose when to exit at private companies. High-quality companies owning high-quality asset means that even in such a window as in '23 you can exit. In the first half of '23, we sold $5.4 billion worth of assets. For example, high-quality infrastructure assets, offshore wind farms at very solid multiples, 2x to 3x times the money. So it's absolutely possible. On the private equity side, we have a longer list of also good quality. We were a bit more moderate on our exit activity as we believe the window will be a bit better in the next 12 months rather than currently.

Stephan, I think we'll wrap up this first part of our CIO macro update here. So we also have time to cover our other asset classes, but if you ask any questions that we didn't manage to get to, then obviously we'll make sure that your Client Relationship Manager gets back to you. So I would now like to invite Kim Nguyen from our Private Equity team to come on stage to cover our Private Equity session. Welcome, Kim, to the webinar as well. And as a reminder, if you have any questions specifically on private equity, then please feel free to start submitting those now. Perhaps let's start by setting the scene a little bit, Kim. Have you seen the market evolve generally compared to, let's say, a year ago?

Sure, Georgina. I'd say we have moved clearly away from a seller's market where short, rapid and very competitive auction processes were the norm. Now the processes have moved through much more bespoke situations where you have a lot of bilateral discussions, whereas bidder, you have more time to spend with the management teams to do your assessment, to form your investment thesis. So clearly, there has been a significant change. We have also seen that volumes have gone down, investment volumes as well as investment sizes. That is, I would say primarily a function of successful transactions being limited primarily to companies that perform well in today's market environment. And so those are usually high-quality assets. Cash flow. Cash flow is a huge topic and focus because of higher interest rate and hence higher service levels for the debt. When it comes to financing, actually, I'd say, leverage has come down dramatically. I'd say we are at an 8-year low when it comes to leverage. And when it comes to sizing really capital structures, the most important factor is not leverage anymore. It's really cash flow coverage ratios. And so that comes back to my point that cash flow is really key.

Great. Thank you, Kim. Let's maybe shift to a slightly different topic that we also had a few questions on in advance of the webinar. AI is a very hot topic at the moment. Everyone's talking about it. So how are you managing the impact of technology disruption across the portfolio and this Partners Group portfolio ready to navigate the age of AI?

Yes. I'd say there are probably 2 facets to this topic. There is, on one hand, the technology disruption and on the other hand, the technology enhancement. So let's start with the disruption part. Clearly, for us, when we look at disruption -- and by the way, it can be technology, it can be disruption coming from regulation, so general disruptions. We look at this topic way ahead of a potential investment. When we do our deep dives into the themes, into the subsectors, we try to understand what are the merits and what are the risks of each of those themes. And so we use our network consisting of senior advisors, of our lead operating directors, as well as our operating directors to have really a good understanding of what those disruptors are. Once we've done an investment, meaning we are comfortable with potential disruptions, then the technology disruption becomes a standard item on our board agenda. When it comes to technology enhancement, that's the other aspect that I'd like to discuss with you or explain to you. This is really for us a standard item in our value creation playbook. So to give you a concrete example, when we invested in EMERIA, which is our property management services company based out of France. Our investment thesis was really about disrupting the company from a technology point of view by looking at their entire processes from the back office over the mid office to the front office and digitalize as much as we can and introduce digital tools. So we implemented a new IT system, gained significant operational efficiencies. We increased EBITDA margin by more than 500 basis points. And then on top of that, we also increased client satisfaction dramatically. So by transforming EMERIA to a AI and tech-enabled business, we have actually disrupted the sector.

Great. And going back to a topic that we've already discussed, we've also had a question come in from an investor in the U.S. talking about the increased scrutiny that we're seeing on private markets valuations, also from regulators. So could you comment a little bit on the private equity side of how you make sure that we can independently verify the valuation process and that's a fair process, at least for the private equity side?

Yes. I'm interested in what the market price is. And so when it comes to our assets, when it comes to our exits, we run multi, I'd say, stage or multifaceted processes that include different type of exit options. So you might have on one side the financial buyers, so other private equity funds or infrastructure funds. You can have strategic buyers and then obviously you can also have the IPO. So when we run an exit process, we would actually tackle all of those options in order to make sure that we get the best possible market valuation.

Great. And what about your underwriting process in that environment? That's another question that we've had come in through the tool. Is there anything that you've changed in that approach given the environment?

Actually, yes, we have. I'd say in the environment where valuation levels were rather high, especially in some sectors that Stephan alluded to such as the technology sector or the health and life sector. We have factored in our underwriting significant multiple contraction to 2 to sometimes even 4 turns of EBITDA multiple contractions. I'd say given the markets have corrected in some of those sub-sectors, I'd say we are still prudent with our underwriting in the sense that we never factor in multiple extensions, multiple arbitrage, but I'd say the contractions in some of the sectors we have limited a bit more. And obviously, the other thing is on the debt and financing packages, they're much more reduced in order to have more headroom on the cash flow cover ratios.

Great. And also a question from an investor in Switzerland. What impact are you seeing from higher rates on the different subsegments of the private equity asset class? Is there any difference there?

Yes. I'd say sectors or companies that require in general a lot of CapEx to finance their growth, I'd say they will be more impacted than companies that have by nature a higher cash flow generation and hence can fuel their growth through their own cash flow. And also companies, platform companies that require a lot of financing in order to fuel their M&A program, I'd say those sectors will be more impacted.

Great. And maybe we can take one final question. Given all this environment and all these changes that we've seen, are you taking a different approach when it comes to working with your management teams as you've done historically, in this more challenging environment?

Well, we at Partners Group, we have a -- we apply a entrepreneurial governance approach, which involves in an active way our Board members. And in general, for each of our portfolio companies, we have a Board consisting of 4 to 5 independent board members, those are our lead operating directors or operating directors. Each of them are usually involved in 1 or 2 strategic projects that transform the company. So usually, we run around 4 to 5 different strategic projects. And hence, I'd say from that perspective, nothing has really changed in the sense that we're consistent with our historical approach by really leveraging on the experience and know-how of our senior advisors and LODs and ODs. I'd say maybe what has slightly changed is the topic. In the past, the organic growth and inorganic growth, the top line growth in general was really at the top of the agenda and hence our board was a reflection of that. I'd say we have become a bit more balanced, top line is still at the top of the agenda, but also complemented with operation improvements and margin improvement. And hence, the board is also -- has also slightly changed with people that have a more diverse set of skills.

Great. Thank you, Kim. We'll wrap up the private equity segment here, and I'll move on now to private infrastructure, which is going to be covered by my colleague, Torborg Chetkovich, Managing Director in our private infrastructure team. So thank you, Kim, and I will move over here to Torborg. So welcome Torborg as well to today's webinar. And as a reminder, please start submitting your questions on the private infrastructure asset class, and I'll be happy to pass these onto Torborg. But again, let's start by setting seen a little bit, reflecting a little bit on infrastructure as an asset class, perhaps. I mean, we've seen it change quite dramatically from a traditional asset class. People thought about utilities, toll roads, bridges, that sort of stuff. But it's obviously moved to a much broader investment universe. So where do you see the best opportunities today?

Yes. Now I would say like this that our investment approach in infrastructure really combines to have the downside protection that infrastructure assets normally provide with a combination of developing a private equity mindset to really secure attractive returns. And also, we have moved away from investing in single assets like one solar cell park or one data center for example, one wind farm. And we are now actually building platforms as we call them, which means that we are acquiring assets in different geographies, in different locations and we also have multiple customers, and therefore, we have more diversified and secure cash flows. And due to the greater scale that we obtain in our way of investing, we also have stronger bargaining power with our suppliers and we can also have increased digitization and automation possibilities. So of course, building these platforms is significantly more complex, which means less competition, but also translating to more benign entry multiples. But to build scalable platforms in a stable and secure way and to find the best opportunities within. Within PG, we have a thematic investing approach where we actually focus on 3 giga teams where we have tangible contributions to really see low-risk and high-growth opportunities. And the mega teams are decarbonization and sustainability. And within that, we are focusing on clean power, low-carbon fuels, and water sustainability. The second team that we are looking at is new living, new mobility, social infrastructure and critical supply chain is in the focus in that theme. And the third one is digitization and automation and it talks about data transmission and we also dive into data storage and service.

Great. Thank you, Torborg. And we had a pension fund based in the Nordics in advance of the webinar asked, what impact rising interest rates might have on longer duration asset class like infrastructure, in particular when it comes to development projects what's your view on that?

Yes. I mean, as Tina was mentioning before, I mean, we expect that central bank's policy rates will remain at current peak levels until probably 2024 in both U.S. and Europe. And we have seen a broad decline in the private infrastructure transactions as markets have had the necessity to actually adapt to rising inflation, higher rates. We also see more lower valuations as been discussed earlier today, volatile markets and also a reconsideration of the energy transition by some. But regardless of the higher interest rates, I mean, we also still see that debt remains available for high-quality asset-intensive businesses. And one example of that is actually our -- when we were refinancing our district heating company, Gren, which is a platform that we are operating out of the Baltics. When we were refinancing it, we actually obtained to get lower -- a better financing package on that round than from the point of time when we did invest in the company, which was back in 2021. And the reason why we were able to do that was really because we have worked very structured and hard together with our board in Gren, together with our management to build out the platform, go into new geographies and also considerably taking -- improving our sustainability footprint in that company. So I would also say that the underwriting approach that we have from Partners Group, we have not assumed that the period of record low interest rates will continue indefinitely. So the current market correction that we see has already been baked into our base case. And also from a DCF perspective, the impact of the rising interest rates was materially offset by the cash flow achieved by our portfolio companies by value creation and also really hard work and focusing on the right things.

Thanks Torborg. And you also just mentioned the energy transition in your response. And I wanted to pick up on that. Is that something that's been challenged more recently with the current environment. So are investments that support the energy transition still attractive?

Yes. We believe it's still attractive. Of course, having a regulatory support from both U.S. and Europe, it helps, but also we need to take some additional considerations while we are looking at energy transition opportunities, as you mentioned, since it has been questioned from some areas. But we remain committed to making investments and accelerating the energy transition globally, because we do think it is important. As an example, Partners Group recently has agreed to invest in Exus Partners, which is an international infrastructure asset management and development firm focusing on the renewable energy sector. And we are committed from Partners Group to continue to build that platform and invest up to EUR 1 billion to grow the company.

Great. And we've also had a question coming through the live tool from a U.S. investor who's asking about the specter of persistent inflation and rising cost of capital on the asset class and saying, isn't this a perfect storm for infrastructure?

Yes. I think it is coming back to our way on really having diligent research on the themes, on the thematic research that we have, where we want to be and also allowing ourselves to really look into where should we go and also finding the really high-quality assets. Of course, I mean, having that knowledge and also then of course, if we can be ready to go in and actually do some good acquisitions and I think we have also proven that during this year.

Right. And we also, Kim has already touched upon this. We also had some questions come in on the impact that AI might have on the asset class. So what impact might this have on infrastructure? What do you see there?

I mean we see AI coming into our asset class as well as an opportunity. And we see it in many sectors. For example, in the healthcare sector, we have recently acquired a company within radiology sector. And there we can see that we can actually improve productivity, for example, in mammography. We also see that we can actually meet the patients at their homes instead of taking them to the clinic immediately. So we can also, both from an availability perspective, but also from an ESG perspective, we can be much faster to actually help. And also because of what AI can offer, the data collection is also we have much more data that we can also use to have the right diagnosis faster. But also another example how we foresee that AI will really help us is in the data center sector, where we already today are invested in 2 high-quality data center assets one in U.S., EdgeCore and one in Europe based out of Iceland at North because we can see that data, the need for storage of data is increasingly massively driven by the AI development.

All right. And we've also had another question come in from an investor based in France, and you've partially touched upon this point, but what challenges do you see in financing or refinancing some of your portfolio companies and do you see any differences across the different sub-sectors within infrastructure?

No, it's a very good question. And of course, to be mindful. I mean, again, we have seen that we have -- and we have been proving also that we have been able to refinance our high-quality assets where we can really prove that for -- that we have done a strong value creation journey from the day when we entered the company, and we can therefore also show that we are trustworthy, that we can also continue to develop this company together with our Boards and management. So of course, being mindful and reading the market, but we are also looking for alternative sources of financing. So it's not only the traditional ways, so also expanding in that area.

Great. And actually, we have a follow-up question from the same investor asking, have you -- what challenges have you seen on the exit markets for infrastructure? To what extent have you also observed some repricings within the asset class?

I would say, in general, the market has been slower in terms of the transaction activity because, of course, market has -- we have seen the interest rates going up. We have seen the inflation rates going up and sellers are maybe a little bit reluctant to accept that maybe this will affect my company. So maybe I hold back a little bit. But when we look at our assets and the ones that we have put on the market, we have actually proven to get really good exits and really good multiples out of those. And again, I think it comes back really from our way of building platforms and having strong boards and strong management teams that can also prove the track record that we have, but also looking into the future. So I think it's a combination of all those. And also something that Stephan was mentioning in the beginning, it's also so that we don't have to sell at a certain point. We sell at the point where we think that we have done our job and also that there is a good market -- a good situation in the market for actually exiting.

Great. Thank you, Torborg. I think we'll wrap up the private infrastructure section there. Thank you for submitting all your questions. We're now going to move on to private real estate and I'm going to be talking to Mike Bryant, our Head of Private Real Estate. So I'll just move over here to speak to Mike. So as a reminder, please start submitting your questions on the private real estate market and I'll be happy to pass them on to Mike and welcome Mike to our webinar. Let's start off by setting the scene a little bit for the real estate market. We've clearly seen some dislocations in the market, especially after the pandemic. So which segments of the market offer the best relative value today?

And look, we're very focused on the living and logistic sectors. And there's 4 reasons that we focus thematically on these. One is we see limited supply. We see low market vacancy rates. We see very good occupational demand in our portfolio. And this comes through in good NOI growth. You have short leases, which give you an advantage and an ability to capture that inflation in a timely manner. And finally, we see a very liquid market. We see a lot of investors and a lot of lenders who are keen to increase their exposure to the sector. But we would acknowledge that it has become expensive to invest in living and logistics. So we use our network of GPs and operators globally to really identify situations where we can source and where we hope and make sure that we invest at a level, an entry price that really reflects today's interest rate environment and today's economic environment. And perhaps going a bit deeper on how we're investing, we will selectively develop particularly in markets where we see there's strong tenant demand for high-quality, modern, energy-efficient properties. We'll look to focus on geographies where there's a high barrier to entry. Typically, urban logistics is an obvious target for that where there is barriers to entry and new supply. And finally, we look to aggregate portfolios. I think we'd much rather build portfolios, buying assets individually because we think that's where you get best value and equally we're able to often source local debt at still quite competitive terms.

Thanks, Mike. And you've talked about different sectors, but let's zoom in for a second on the office sector which I think is on a lot of investors minds. So can you still find attractive investments in the office space?

I'll perhaps answer that question last. But look, I think it's tough in the office sector, but I would say that is a generalization in itself. We're a global investor with a global portfolio and we can see real differences by geography and equally by type of asset. And by geography, I mean, I think we would contrast maybe U.S. gateway cities, where it is very tough, in contrast to maybe certain geographies in Asia where remote working and working from home is just not so culturally relevant. In terms of looking at the office sector, I think I have 2 sort of more positive perspectives. One is I talked a bit about the flexible working policies. My sense is that there's a lot of organizations out there that are still refining their flexible working policies and look, the data that I see, what I read is many companies are asking their employees to come back into the office in a more significant way. And I think that is good for office occupancy and use and ultimately for the sector. I think the second topic is the leasing market hasn't fallen off a cliff. I think we see a bifurcation in the market and we certainly see it as a landlord. If you have functional and economic space, it's -- as long as you're clear with what your value proposition is, I think there is still good tenant demand. And at the other end of the spectrum, I think if you have high-quality, green, energy efficient, there is good demand from corporates that really want to occupy these types of assets and really welcome their employees back to the office. So those are 2 positive perspectives. I think secondly, perhaps in a less positive way, is investor and lender sentiment to the sector. That's clearly weak at the moment. Liquidity is down. And I think that's the contrast of what I said earlier on in terms of the investor and lender appetite that we see in the living and logistics sector. So overall, it's tough. I think there is distress out there, I think a lot of investors, and I would include ourselves still remain on the sidelines.

All right. Thanks, Mike. And we've also had a few questions come in on cap rates. One investor in the U.S. is asking where do private market cap rates stand versus public comparables and REITs for kind of overlapping industry exposures?

I think it depends and it may sound like a lazy answer and it's not meant to be a lazy answer, but I think you really have to look at the specifics of individual sectors and equally individual assets. Clearly, higher in interest rate environment, all things being equal, will lead to a higher cap rate environment. I don't think the correlation is necessarily one-on-one. But certainly, through our portfolio, we look to value our assets regularly. We use third-party external appraisals, and it's clear cap rates have gone up. But equally, on the cash flow side, where we are able to generate more value that does compensate against the rising cap rate environment.

And actually, just a follow-up question on cap rates. Do you see any differences across different subsectors in terms of relative values?

Look, I think if you look at the living and logistics sector, you might look at cap rates and you'll look at the current interest rate environment and you'll say those cap rates look quite low. But again, I think the devil is in the detail because what investors are -- if they're paying cap rates that look quite low, it's because of 1 or 2 reasons. It's all to do with the rental growth they think they can generate and that might be a consequence of market rental growth that's already happened, but you haven't been able to capture that in your lease contracts. So that's the rental reversion that might justify what would look optically a low cap rate or future rental growth that people would expect. I talked about these short leases that clearly give you an opportunity to capture that market rental growth, that inflation rental growth in your numbers. So I think you will see lower cap rates in living and logistics for those reasons.

Great. And we've also seen more pressures on the core real estate sector. Many investors are looking more to value-add strategies today. Could you comment a little bit on that and why a value-add approach makes sense?

Look, for me, I think it's quite simple math, and I think we can contrast today to maybe 3 or 4 years ago. Today, debt costs are frequently higher than entry cap rates So you have so-called negative leverage. And therefore, the economics as a landlord that you would get from collecting the rent are much reduced because of those higher debt costs. Therefore, if you want double-digit returns value creation has to be at the heart of your business plan and that is why I think a lot of investors are choosing to allocate money to value creation strategies because they recognize that simple math.

Great. And maybe we have time just for one final question. Could you also comment a little bit about the opportunities that you're seeing in real estate secondary market?

Of course. And look, I think whether we're a direct investor or a secondary investor, we have the same thematic focus on living and logistics. Look, I think the holy trinity of a secondary, good secondary investment are assets you like, a GP you like and an entry price that makes sense for you. Now we can invest in a couple of ways. We can buy portfolios of LP interests. I would say at the moment, it's probably by exception that we're able to tick those 3 boxes on a portfolio of LP interest. However, we do spend a lot of time on GP-led secondaries where we can really select the assets we want, where we have thematic focus, work with GPs and help shape transactions. So we do see good investment flow, more typically in GP-led secondaries at the moment.

Great. Thank you very much, Mike. I think we'll wrap up the private equity section there and move on to private debt. So I will move over to speak to Carina Spitzkopf, a senior investment leader in our private debt team. Welcome Carina to the private debt portion of the webinar. As a reminder, please feel free to submit your questions on the private debt market. And Carina, as for the other segments, let's maybe start by setting the scene a little bit. We have seen bank lenders retreat, obviously, from the market and tighten their lending conditions. So what opportunities has this created for private credit?

Yes. I think in addressing that question, it's probably worthwhile briefly stepping back and differentiating as to what development we've seen in the banking landscape post the great financial crisis, i.e., all those 15 years ago and what it is that we witnessed more recently. So the typical banking financing model about 20-years ago would have been or would have seen bank lenders, which by the way included commercial banks as well, to operate on a lend-to-hold basis. So, management sponsors will actually speak to the lenders that they would end up cooperating with or going into partnership with directly. Whereas following the GFC and certain regulatory changes that were then put in place, we actually saw a shift in that banking model setup. And we really moved to an underwrite to distribute banking model as opposed to lend-to-hold, which meant underwriting banks, typically investment banks, would function as an underwriter and then distribute to the likes of CLOs and really simplify the banking model as we know it today. The introduction of investment banking is functioning as an underwriting solution provider, however, meant that there is a sort of intermediation of that originally direct relationship between borrowers and their respective lender audience. And that intermediation is really what the current banking model of those IPs into challenge over the most recent periods. And that's really what's created an amazing opportunity for private debt managers to step in and sort of take away that degree of uncertainty because we're sort of moving back to the element of talking to borrowers directly, borrowers talking, sponsor talking to us as lenders as an immediate counterpart. And counterparts also play a role because we frequently see direct lender situations to involve only either a single lender or a smaller club of lenders for example. So you also reduce that complexity of stakeholders that are involved in the process. And that's private debt has really been able to step into that gap that was provided over the sort of last 18 months and enable that sort of long term partnership that we've proven over the most recent challenging times.

So you've just spoken now about this great opportunity for private debt and we also had a couple of questions come in in advance of the webinar from a U.S. investor asking, with all this capital raised for the private debt market, is it a crowded space now? Is this compromising the quality of investments in any way?

Yes. The space definitely has seen more players enter the market. So I think there's no beating about that fact. However, we would also note that the players in our markets very much differ, differ in geographic coverage they offer, in capabilities they offer, in risk appetite they offer, so really room to differentiate oneself. And I think more importantly, even there still is a very big market for everyone to play with. So I think there is a degree of competition, that's also for sure. But at the same time, we would note that's probably the case for the most contested asset, i.e., really high quality where you might see the whole market, including private equity by the way, to be all over it. But especially, on non-auction more bilateral processes we see big opportunity to still play a role and for everyone to have their bite of the market.

Great. Thanks. And we also had quite a few investors asking about our outlook on default rates. So do you see any growing signs of distress in the market? What's your view on how default rates might evolve?

Yes. So definitely, the recent economic pressures, and I say recent, actually, it's been a number of years now that we've seen all sorts of factors play and feed into the finances of our portfolios, be it base rates increases, labor, inflation pressures et cetera. So there is an element of pressure across portfolios across the globe, so that's for sure. And also, worth noting probably that a lot of these impacts only really start showing because things like base rates, I think some of us might have forgotten, only actually not that long ago, that things like Euribor went from negative to positive and accelerated quite quickly. So looking at sort of rolling forecast in terms of LTM last 12 month numbers, for example, when analyzing the financial performance of our portfolio companies, you would only maybe just over the last 12 months see those pressures really feeding through. So I think to answer your question, default rates, I think is also worth to take with a pinch of salt because it's really important to understand what is the underlying data that feeds into those stats and keep dynamics in mind such as cov-lite credits which probably will never end up in those type of stats because by the time there should be a trigger, it just won't be triggered and therefore, will never feature in that analysis. But there's also no doubt that I think we will -- we are in an elevated stress environment, and we will stay in an elevated stress environment for a little bit longer I think. But say even more important, as we are a debt product and that's down side protection really is key. That's in our analysis and when we go about investing, we made extra sure that we run sensitivities, be it around things like base rate increases and potential for that, or sensitivities around what could a potential downside case look like, et cetera. To really make sure to protect profitability of our borrowers and their cash flow generation ability and provide them with the required resilience to sort of weather these storms and make sure that at the outset, we ensure right sizing of debt packages to whether those potential pressures coming.

Great. We've also had a question come in looking a little bit about the sectors that we're looking at right now. So are there any sectors that we're avoiding currently in these market conditions?

So we like to say that we are sector agnostic as such. So in general, we would say that we are happy to consider every type of business. But having said that, businesses even in same sectors can differ substantially once you drill into the sort of sub elements of those respective industries. It's probably fair to say that sectors like hospitality, certain where there's a lot of exposure towards retail customers, for example, have come under a lot of pressure, and then you have things that weigh on the cost side of things as well, such as rising rental prices, et cetera. So we would tread very carefully when it comes to these types situations. And of course, there are sectors such as typically IT services related or healthcare. But again, really very much subject to what subsector we're talking about that are popular go-tos from a lending perspective, but having said that, we are always prepared to take a proper look and really make sure we understand the ins and outs of business models before coming to a conclusion.

Great. And if you've mentioned also the there's an increasing relationship between direct lending and the Board is syndicated loan market and Partners Group operates on both sides of the spectrum. So how do you manage this relationship given we operate on both sides of the market?

Yes. So these days, as it's available to especially larger credits, borrowers and sponsors would typically try to explore both routes, i.e. capital markets and the private debt route when they look to optimize the funding requirements. And as I mentioned earlier, over the most recent period, this is really where private debt has proven its worth and really demonstrated that we're a very reliable route in these type of uncertain times, providing that much needed certainty. However, as cap markets are looking or looking like they're going to make a comeback, that type of optionality, running a dual track process, i.e., exploring kept markets and the private debt solution, will surely see a bit of an acceleration. But given that Partners Group would play, as you mentioned, both sides, i.e., we operate in the broadly syndicated loan, i.e. cap market space as well as on the private debt side of things, we are very well positioned actually to benefit from those developments, whatever route is chosen, so to speak. And from our angle, we benefit and are able to make use of the fact that the sponsor universes overlap to a quite significant degree. And also in terms of how we operate and go about investing, we are able to tap the sort of industry insights that comes from our BSL capital markets investor teams on the private debt side and vice versa, actually, a lot of private debt credits actually end up being capital markets issues at some point. So we're really able to make the most of that sort of insight.

Great. Thank you. So we'll look forward to seeing how you continue to make the most of that insight. I think we can conclude this session now. So thank you very much to everyone for joining us today. Thank you for the many question you submitted both in advance and during the live webinar. If there are any questions that we did not manage to get to, throughout the session, we'll ensure that your client relationship manager gets back to you directly with a response. Thanks again for your trust in Partners Group, and I wish you all a successful rest of the day.