Private assets – the opportunity to uncover gems in an uncertain world

Private assets – the opportunity to uncover gems in an uncertain world

Private investments have shown a remarkable capacity to deliver appealing returns over the last 20 years and, despite a challenging macroeconomic picture, they still offer the potential for attractive returns over the long term for agile investors who are prepared to lock up their money for several years.

Private assets are held in investments that are not publicly traded – such as with private equity, privately managed real estate funds, private credit and infrastructure. Their appeal is that they can afford access to unique assets and some of the most innovative companies before they are listed publicly, and that they can fill market gaps when publicly listed firms retreat. The trade-off is that investors need to be ready to invest capital for the long term and be ready to show patience to see returns. They also need to accept that some companies may not fulfil their promise – a risk that underlines the case for diversification in portfolios.

Over the last two decades, the asset class has capitalised on its potential to create value (by working with a company’s management in private equity, for example, or improving a building’s energy efficiency in real estate) to often outperform publicly listed companies. That track record is now facing headwinds from a tricky economic environment. 

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Stubbornly high inflation has put pressure on businesses’ margins and on central banks to keep interest rates higher for longer; the higher rates in turn raise the cost of financing for companies and private equity managers; and valuations are already elevated.

However, these factors affect public equities too – and investors in private equity may be well placed to adapt to these circumstances and create value independent of macro conditions since private equity managers have control over holdings, access to a broad opportunity set that includes some of the world’s most innovative and robust companies, and longer-term perspective.

This mix of economic risks and investment opportunities is nevertheless likely to lead to wider dispersion in the performance of private equity funds, so experienced manager selection and appropriate diversification is essential. In a nutshell, selective investments in quality private assets could offer further appealing returns.

Private equity

Since peaking at more than 8,000 in 1996, the number of companies listed on US stock exchanges has approximately halved. In addition, the vast majority of US businesses with annual revenues above $100 million a year are private.

In today’s challenging macroeconomic environment, mutually reinforcing factors can help private equity managers focused on operational improvement in their quest to generate attractive returns:

  • Value creation through active ownership: Private equity firms exercise significant influence over all a company’s decisions and can meaningfully improve its strategic direction and create value.
  • Alignment of interests: Private equity firms and business managers invest in close partnership, ensuring strong alignment of interests across all stakeholders.
  • Long-term perspective: Private companies do not have quarterly pressures to report strong earnings to the market, so can instead focus on necessary long-term improvements.
  • Deep industry knowledge: The best private equity firms know how to achieve the full potential of a company, typically having learned from several successful investments within the same industry.
  • Information access: Private equity firms have privileged access to non-public information at target companies, allowing for enhanced due diligence and therefore potentially better investment decisions.

Opportunities open up…

Issues in early 2023 with some banks being poorly capitalised led to a refocus in the sector on capitalising balance sheets, reducing risk-weighted assets for banks. This has meant less appetite for lending. Banks withdrawing from lending and higher interest rates have combined to make it harder for companies to borrow money from traditional sources. 

But when banks retreat, opportunities open up for private credit – especially now given high demand for financing. A maturity wall looms, starting in 2024– creating a significant amount of debt for refinancing. Debt that was refinanced between 2010 and 2012 was refinanced at lower rates. So there is a big difference between the kind of refinancing seen back then, and what businesses are facing today. This feeds into the cost of debt for borrowers, and presents opportunities for extending private funding.

Indeed, private credit is already filling the funding gaps left by banks, with tight financial conditions offering scope for exploiting high-conviction opportunities. Against this backdrop, properly calibrated private credit strategies focused on quality can generate attractive returns.

In 2024, private asset strategies may present interesting opportunities to tap into appealing long-term investments while continuing to afford access to some of the most innovative companies before they are listed publicly. Sagging valuations could mean that this year turns out to be a good ‘vintage’ (the year a fund starts making investments) for both private credit and private equity funds.

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