Tuesday 12 December 2017

Nordic fund chief warns market shock is coming

EQT partner, Thomas von Koch, worries that markets will turn if President Trump fails to get any of his proposed changes through Congress
EQT partner, Thomas von Koch, worries that markets will turn if President Trump fails to get any of his proposed changes through Congress

Niclas Rolander

The biggest Nordic buyout fund is turning to the most stable industries to protect itself from a market upheaval it says is coming.

Thomas von Koch, who runs EQT Partners AB from Stockholm, says that with central banks needing to unwind their balance sheets and political risks on the rise, markets look like they're headed for a sizeable shock. And the in-tandem movement of different asset classes means there's basically nowhere for investors to hide, he said.

EQT is doing what it can to prepare its portfolio of companies "because the storm will come," the managing partner said in an interview from the fund's head office in Sweden's capital. "There's a tornado warning and we're in the prairies of the Midwest. We just need to prepare for when it strikes us."

Von Koch says asset values are unnervingly high. A lot of buying is debt-funded and there are too many potential disruptions ahead, he said.

He cites historically big balance sheets at the Federal Reserve, the European Central Bank and the Bank of Japan, all of which will need to be unwound at some point, sucking cash out of the world's biggest economies. He also worries that markets will turn if US president Donald Trump fails to get any meaningful legislation through Congress.

"When the change man can't change anything, when he's stuck in Washington like everybody else," then there's a risk that the "business community turns on Trump," von Koch said. "That would be an interesting event."

It's not all doom and gloom. Von Koch, who correctly predicted Britain's exit from the European Union and Trump's election win, says the French election left him "more optimistic about Europe than I've been for a while."

The CEO says private equity can outperform other investors because it can directly influence the way its portfolio companies are run. EQT is hiring more tech-savvy people to digitise all corners of its empire, which von Koch says is crucial to staying agile and surviving market ups and downs. The fund's employees are also expected to be up on the latest, when it comes to technology and its workplace benefits.

"We're drinking our own Kool Aid," von Koch said. "If we're telling everyone else to become agile we need to start with ourselves."

Among the stable industries that EQT likes are broadband infrastructure and healthcare services. Healthcare "needs to be reformed," von Koch says, "and it can't be done without the private sector." In October last year, EQT bought Press Ganey, which makes analytics tools for health care companies, in a $2.35bn (€2.16bn) deal.

EQT (Scandinavia's biggest buyout fund, which was co-founded by the Wallenberg family's Investor AB) invests in unlisted companies, in real estate and infrastructure, and in credit. It has raised about €35bn in funds, €22bn of which is invested in portfolio companies across the globe. Of late, EQT has been inundated with cash as institutional investors, pension funds in particular, turn to private equity to help generate extra returns.

But von Koch says investors need to start adjusting their expectations. "Let's be honest, the returns must come down," he said. "The capital raising in our industry is exuberant."

He says that if a stock market crash comes, the abundance of capital could quickly evaporate.

"The dry-up of capital to our industry could happen in a month," von Koch said. "We are in a very shaky place, and nobody has taken any account of it when it comes to asset pricing. It's just a bonanza."

He also voiced concerns about a recent Swedish tax decision which may be devastating to investments in the country. He says he's in shock after a Swedish court ruled that he and others working in his industry will need to treat income from investments as salary. The decision, which affects income earned as long as a decade ago, may make it hard for parts of the industry to continue operating in the country, von Koch said.

"The implications for the whole financial system are immense," the EQT chief executive officer said last Friday, shortly after the decision was announced.

The Stockholm appeals court ruled that some of the profit-sharing from investments in private equity funds should be treated as salary rather than capital gains, backing the tax authority's argument that partners were employees in consultancy firms, paid in carried interest. The decision, which affects about 85 employees in the industry, marked a victory for Sweden's tax authority after it lost a similar case in the same court in December 2013.

The tax authority argues that because payments are partly based on performance, they can be regarded as salary. It estimates that affected employees will need to make additional tax payments of 2.3bn kronor (€237m), though von Koch says the real number is probably much higher.

After the previous setback, the authority asked courts to retry the case, based on new arguments, to claim higher tax payments for the years 2007 to 2012. Von Koch said the drawn-out legal process has injected unpredictability into corporate Sweden that threatens the country's investment future.


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