How a gap in the banking sector is generating returns

It's not often that the terms "increased regulation" and "opportunity" appear in the same sentence. But for the team at Apollo Global Management, it's a theme they look at closely. It's been nearly two decades since the start of the Global Financial Crisis, with the ramifications being significant regulatory changes across the globe. One of those changes tightened lending requirements on banks and thus left an enormous gap in the market.

It's a space that businesses like Apollo Global Management have been able to step in and fill.

“In many cases, we are able to take very experienced, seasoned professionals that have been managing businesses for a long period of time, reconstitute them outside of the bank and stand up really successful businesses,” says Eric Hanno, co-head of Apollo Aligned Alternatives.

But what gets Hanno most excited about this particular investment theme are the potential returns.

In this episode of The Pitch, Hanno discusses the different strategies Apollo uses, and how post-GFC regulation became an opportunity.

Note: This interview was taped on Wednesday, July 17th 2024.

Edited Transcript

Can you discuss the Apollo strategies with a brief explanation of each?

There are several strategies that we focus on.

The first one is core private equity.

Think of it as a Warren Buffett-like strategy where we're trying to buy high-quality companies with predictable cash flows that we feel that in a downside or a stress scenario, we think these companies can survive and we don't lose our principle.

In those types of investments, when you can buy in or find a deal like that, typically the mindset is that you actually want to hold it for a longer time period than what is typical in private equity. In private equity, you might hold a company for four to six years. In our core private equity strategy, our mindset is that we could potentially hold that for 10, 15, 20 years or into perpetuity.

The second strategy I'll highlight is called structured equity. 

Structured equity is a bespoke flexible financing solution that fills the gap between what banks will do and what control private equity firms will do and we are one of the largest bespoke financing providers in private markets. In general, we're trying to underwrite to an equity return, but typically we're coming into a credit-like security where we're senior in the capital structure. What that means is the equity needs to be wiped out and worth zero before we're impaired on our principle. That really creates an asymmetric risk-reward profile. 

In addition to structured equity, we will opportunistically invest in private credit markets. We are not using private credit markets as a liquidity sleeve within our strategy. We're actually using it to find credit securities where we think we can achieve equity returns, but do that when we're coming into a credit security. So again, we have some asymmetry in that we're senior in the capital structure relative to the equity, but still delivering that equity-like return.

We also pursue private equity secondaries. That's a situation where someone owns a private equity fund or asset or a GP [General Partner] wants to do something unique with their fund. Inside Apollo, we have a team that's dedicated to finding interesting transactions in that space.

And also, we will do some traditional private equity. We view that to be a great strategy, but a higher-risk strategy. 

Then, finally and opportunistically, we may consider other asset classes such as real estate or infrastructure or just other interesting transactions that come up through the Apollo organisation. As you can tell, we have many different strategies that all have different roles and all can be more or less attractive at various points in the cycle. We feel quite lucky to have so many areas to focus on within such a large firm like Apollo.

What strategies are you favouring in the current environment?

There are a couple of areas that we're leaning in right now.

First of all, I talked about our core private equity strategy. 

Any time that you can buy into a high-quality company with predictable cash flows that you want to own for a long period of time that you think, even in a bad scenario, you don't lose the principle that you invest, you want to do that. 

We think the volatility in this environment is creating an attractive entry point.

In addition to that, the increase in interest rates from near zero to 4-5% across various developed markets across the world is causing a lot of financial distress. 

What's the deal pipeline been like and of the next 100 deals to hit your desk, how many might typically result in investment?

We are in the very lucky position of being part of one of the largest private market asset managers in the world with many different strategies and investment professionals. We have almost 800 investment professionals spread across the globe. We are spoiled for deal flow. We see thousands of transactions every year, and we only do a handful of those deals.

If we saw 100 deals, I think we'd do one or less from where we sit.

I would just comment that more broadly, if you look at the private markets, particularly on the private equity side, deal volumes have been quite low because there still is a bid-ask from a valuation perspective with interest rates having gone from zero to 4-5% across the global economy. When something like that happens, it takes some time for pricing to reset in traditional private equity markets.

We also are value hunters. We take advantage of volatility and changes in the marketplace. As markets may be slow for more traditional private equity strategies, I think a lot of the strategies that we pursue within Apollo are quite active and there's a lot to look at. We're quite hopeful in this market environment, and I think we've been successful at finding a lot of attractive opportunities.

What deals have gotten you most excited in recent times and have brought the most value to investors?

I think there are a couple of trends that we've seen in the broader industry, and one is just a result of some regulatory changes that we have seen really across the globe, but in particular in the US and Europe. Coming out of the financial crisis, a lot of the regulations made it much more difficult for banks to continue in some of their traditional business lines. There has been a period of time where there's not as natural a home for some of the financing businesses that banks have historically done in their entirety. We see an opportunity within financial services, within financing platforms, to step in and fill a void that banks are no longer looking to serve. 

In many cases, we are actually able to take very experienced, seasoned professionals who have been managing businesses for a long period of time, reconstitute them outside of the bank and set up really successful businesses.

We see tremendous growth there. 

Seeking to provide excess return along the risk-reward spectrum

Founded in 1990, Apollo is a high-growth alternative asset management and retirement services firm. Apollo seeks to provide its clients excess return at every point along the risk-reward spectrum from investment grade to private equity with a focus on three business strategies: equity, hybrid, and yield. Find out more here