Against the backdrop of the continued geopolitical conflict in Russia-Ukraine, a slowing/recessionary Europe and sticky inflation, a few macro events which had been accepted as fait accompli have surprised positively. A possible US recession, a tech collapse akin to 2001, China de-growth are all events which most investors had discounted towards the end of 2022. However, the global economic news specifically from the US, China and India continues to exceed expectations in a positive manner. It is nobody’s case that the global economy is out of the woods yet. We are likely to continue with elevated interest rates, high inflation, and sluggish global growth (~2.8%1). Yet it is certainly not doomsday. This is manifesting itself in capital flows redirecting globally to promising bright spots in the world economy. India continues to be a beneficiary of this trend. The country recorded net capital inflows (FPI flows) of USD 7.7 bn2 for YTD 2023 against a net outflow of ~USD 18 bn in 2022 resulting in the Nifty 50 being up by 4.2% YTD. Encouraging lead indicators - petrol and diesel consumption growth (11%/13% YoY)3, GST e-way bills (up by 20% YoY)3, auto registrations for two-wheelers and passenger vehicles (up 12%/6% YoY)3, online transactions (up 35%+ YoY)3, rural wage growth (up 6% YoY)3, a sustained drop in inflation (<5%)3, and surprising pockets of growth in export of services, farm output, and construction activity have all been catalysts in the growth. Furthermore, credit continues to flow at a healthy pace (mid-teens), primarily driven by government spending and personal credit. GDP growth at 6.1%4 in Q4 FY23 was driven by a steady growth in private investments and significant public capital investments (GFCF grew at 11.4% in FY23)4. Private consumption did grow at 7% in FY234 but is showing signs of slowing down – largely due to inflation and fear of an uncertain monsoon.
Private markets have witnessed a revival of deal flows although closures are taking longer as deeper diligence is being conducted and investors continue to be very choosy and selective. This is manifesting in the ~USD 24 bn5 of PE/VC investments YTD. We are clearly witnessing a divide between the ‘haves/ have nots’ in the private space where investors are only investing behind businesses/entrepreneurs which tick all the desirable ‘must-haves’.
There are two key concerns about private markets that I would like to address specifically and are very relevant from your perspective. The first is governance. Like all industries, private markets also have their share of bad apples. Recent press reports about governance lapses at several start-ups and some situations of accounting fraud are a very serious blow to the evolving ecosystem. Both investors and entrepreneurs should exercise caution and take proactive measures to prevent such behaviours from taking root.
The second issue is about the methodology and variability in private company valuations. While most funds follow the IPEV6 guidelines, there is enough scope for interpretation and subjectivity to cause a significant delta in valuations using different methodologies. SEBI too in its recent circular7 has mandated, for funds, far more stricter guidelines for valuing private companies.
At the Avendus Future Leaders Fund (‘the Fund’), we are very conscious and sensitive to these investor concerns and are actively working towards increasing our diligence and monitoring scope for our potential/existing portfolio companies. As regards valuations, we have, since inception, used a Big 5 accounting firm for valuing our portfolio companies so that investors get an independent perspective on the extant valuations. Despite these challenges, we remain optimistic about the future. We anticipate a pickup in investment activity in the coming quarters. Many companies that secured substantial funding in 2021 are returning for subsequent rounds. Market-leading companies with robust growth at reasonable valuations will attract investments from fund managers sitting on substantial quantum of dry powder. Additionally, founders who have adapted to a tighter liquidity environment and are focusing on outcome-based capital utilization and are pursuing a balanced strategy of growth and profitability will find greater alignment with the investor community.
Source: 1. IMF, 2.NSDL (till June 23, 2023), 3. Jeffries Equity Research Report dated June 19, 2023, 4. Ministry of Statistics and Programme Implementation, 5. IVCA-EY report, 6.IPEV: International Private Equity Valuation Guidelines) and 7. SEBI Circular dated June 21, 2023