megatrends
Portfolio Implications
The New Dynamics of Private Markets
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A seismic shift in the investment landscape has occurred with an array of long-term investors increasing their allocations to alternative assets and private markets. But the shift to private markets goes beyond simple changes and has implications that ripple across investment portfolios. While this trend creates new investment opportunities, it also raises new and very different kinds of risks for CIOs to consider.
40%
Percentage of private equity investors that said they invested in ESG-related products in 2022 – up from 33% the prior year.
Portfolio-wide investment implications
Portfolio-wide
ESG
liquidity risk
private credit
private credit
Portfolio-wide
liquidity risk
Private Credit Investment Implications
Banks have historically been dominant players in most segments of corporate lending, but have lost a significant share over the last 20 years. While banks increased their overall share after the GFC, regulatory changes around the implementation of Basel III standards have made them much less competitive and unwilling to lend in the riskier and highly leveraged portion of the market. For example, their share of leveraged loans – often associated with highly levered private equity buyouts – has halved from 30% in 2009 to 16% in 2021.
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The seismic shift in private markets has long-term implications across the entire portfolio.”
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A shifting paradigm for private markets
Private Equity Enters a New Phase
Portfolio Implications
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Private Equity Investment Implications
Portfolio-wide Investment Implications
Private credit expands its reach
1. Manage credit exposure holistically
The lines between public and private credit markets are increasingly blurring (e.g., direct lenders into broadly syndicated loans)
Investors need to view their entire credit exposure collectively to capture opportunities as well as overlapping risks and correlations
2. Look beyond sponsored lending
Attractive investment opportunities in private lending lie beyond the crowded segment of sponsor-backed deals
Seek out direct lending platforms that can source non-sponsored deals and have a strong underwriting and credit track record to navigate across multiple market cycles
3. Energy infrastructure offers unique opportunities
Smaller firms are disproportionately impacted by banks retreating from the conventional energy sector
For investors whose ESG policies permit, structured loans on proven wells can offer attractive coupons and added upside protection in the form of equity or royalties
4. Traditional structured products
Despite the novelty of the more “exotic niches” of specialized lending, their credit scoring models have yet to be tested through a full credit cycle (e.g., “buy-now-pay-later” models)
Traditional structured products – such as CLOs and CMBS – offer tested credit models and structures as well as favorable capital treatment
5. Multifamily rental housing
Post-COVID trends – including a surge in household formation and elevated global home prices – provide a favorable macro backdrop for multifamily rental housing
Multifamily also offers debt investors some inflation protection and better performance through a credit cycle
1. Secondary markets create new flexibility and opportunities
In addition to creating liquidity, secondary transactions provide a portfolio management tool to implement a change in investment strategy or dampen the J-curve of primary funds
Secondary markets can create opportunities for buyers who can provide liquidity in times of market uncertainty and elevated discount to net asset values
2. Closely monitor PE fund practices and structures
Restructuring and continuation funds involve value transfers that may create potential for misaligned incentives between GP and LP that need to be evaluated
If misused or undisclosed, subscription lines can distort performance metrics and be a source of embedded leverage
3. Reconsider the role of
Venture Capital
VC risk-adjusted returns have lagged other private market strategies since the early 2000s.
However, CIOs can benefit from the vision and market intel of VC management and portfolio companies to identify potential vulnerabilities and targets of disruption in other parts of their portfolio
4. Renewable and digital infrastructure provides global opportunities
As renewable power ramps up, there are opportunities in adjacent areas such as energy storage and low-carbon hydrogen
Hyperscale data centers – large-scale facilities that cater to the biggest cloud providers and tech companies – offer attractive investment opportunities globally
1. Blurring lines require more flexible investment approaches
Investors need to reconsider their approach to investment analysis and decisions as the lines between public and private capital markets are increasingly blurring
This requires better collaboration between analyst teams and potentially a re-evaluation of public-private boundaries in investment mandates
2. A more sophisticated understanding of liquidity risk
As investments in private markets grow, so do questions around portfolio liquidity and optimal allocations
A customized portfolio framework that spans asset classes and time periods can enable a deeper understanding of portfolio liquidity risk
3. ESG is beginning to shape private markets
ESG-minded investors are driving change around detailed disclosures and more accountability
Direct ownership and control can provide ideal circumstances for an ESG-minded investor to achieve impact objectives and goals
4. Private assets in defined contribution retirement plans
The benefits of making private alternatives accessible to individual investors are apparent
Liability risks and uncertainty provide high hurdles; CIOs should look for ways to responsibly incorporate private market investments into defined contribution plans
retirement plans
ESG
liquidity risk
Blurring lines
retirement plans
ESG
liquidity risk
Blurring lines
Blurring lines require more flexible investment approaches
Investors need to reconsider their approach to investment analysis and decisions as the lines between public and private capital markets are increasingly blurring
This requires better collaboration between analyst teams and potentially a re-evaluation of public-private boundaries in investment mandates
A more sophisticated understanding of liquidity risk
As investments in private markets grow, so do questions around portfolio liquidity and optimal allocations
A customized portfolio framework that spans asset classes and time periods can enable a deeper understanding of portfolio liquidity risk
ESG is beginning to shape private markets
ESG-minded investors are driving change around detailed disclosures and more accountability
Direct ownership and control can provide ideal circumstances for an ESG-minded investor to achieve impact objectives and goals
Private assets in defined contribution retirement plans
The benefits of making private alternatives accessible to individual investors are apparent
Liability risks and uncertainty provide high hurdles
CIOs should look for ways to responsibly incorporate private market investments into defined contribution plans