By Vishal Soni

Several institutional investors have established or raised the target allocation to the private markets owing to its exceptional performance in the last 10–15 years. With public markets being volatile, there has been an increase in the interest of new-age investors in unlisted asset classes. The actions have been driven by a myriad of factors.

Over the past several decades, private markets have consistently outperformed public markets, providing opportunities to access innovation and value creation that may not be present in the latter. According to a survey by Adams Street Partners, over 86% of investors say that private markets outperform public markets in the long term.

The markets might have emerged from the turbulent year, but the fear of recession still prevails as we navigate through 2023 and prepare for 2024. Furthermore, factors such as inflation, market volatility, and rising interest rates are some of the looming challenges.

However, historically, the uncertainties have always made private space lucrative. Even during the COVID-19 pandemic, the private markets delivered exceptional results in the second half. Furthermore, in 2022, when the central banks increased interest rates, the public markets cratered. But in the private markets, despite the deal activity plunging a little, it still matched the results that were delivered in 2021 and outpaced the public markets.

For private financial markets, the last decade has been particularly prosperous. The private markets have been experiencing record deal flow and fundraising while also celebrating robust performance across asset classes.

In over 14,000 transactions totalling over $2 trillion, the volume of global buyouts and growth deals increased by almost 50% year over year, according to “McKinsey Global Private Markets Review 2022. In addition, the AUM in 2022 also reached $11.7 trillion, along with the dry powder exceeding $3 trillion, reflecting an 8.4 percent year-over-year increase and marking the eighth consecutive year of growth.

The private debt fundraising industry also experienced a spike in the past two years. In the first half of 2021, 540 funds raised over $379 billion in primary capital, according to the Preqin database. When compared to 2020, the total amount across all 401 funds was $190 billion.

As a result, investors have become more and more interested in balancing their portfolios of low-yielding bonds with higher-yielding unlisted asset classes. Investment in unlisted asset classes has been made easier by structural changes in the real asset economy and more developed operational procedures in private markets. They have started filling in the gaps in their own operational model due to the uniqueness of investing in private markets.

More focus on private credit

Private market returns have a low correlation with those of the public markets. As a result, private market investments can contribute significantly to portfolio diversification and, over the long run, can provide enticing absolute and risk-adjusted returns.
As other assets decline and a recession approaches, private credit is expanding and providing investors with more opportunities for returns. Preqin states that private debt funds are anticipated to have an average rate of return of 8.4% by 2027. As a result, investors consider private debt to be appealing due to the asset class’s capacity to generate contractual returns, produce a higher yield premium in a rising-rate environment, and offer a suite of diversified strategies that can be effective under a variety of market conditions.

Furthermore, private credit managers continue to be optimistic about their business prospects despite growing macroeconomic uncertainties. According to the most recent report from the Alternative Credit Council, more than 80% of private credit managers globally are either bullish or cautiously optimistic about the market’s prospects over the coming years.

Private credit managers are feeling upbeat at a time when investors are looking more closely at opportunities in the asset class. Furthermore, among the highest percentage of all alternative asset classes, 51% of investors intend to increase their allocation to private credit in 2023 and beyond, according to Ernst & Young’s most recent global alternative fund survey.
Infrastructure gaining ground
Despite not being immune, core private infrastructure assets are still resilient in such volatile and uncertain times because the services they provide are essential, inflation protection, commodity cost pass-through, and strong cash flow generation are present. Furthermore, due to structural tailwinds from the need to update, replace, and decarbonise current assets, there are several appealing investment opportunities in core private infrastructure.

The private markets managers are also taking ESG factors into account when making corporate policies, operational practises, and investment decisions, according to a report titled “McKinsey Global Private Markets Review 2023”. In 2022, a record-high 66 percent of all private capital fundraising came from managers whose investment policies take ESG issues into account.

Infrastructure has drawn the attention of investors due to a number of appealing characteristics, including low sensitivity to changes in the business cycle and cash flows that are indexed to inflation.

Additionally, there is still a critical need for infrastructure investment, which calls for private funding to guarantee the sustainability, affordability, and dependability of vital services.

Even if at a slower rate than in 2021 and 2022, fundraising inflows are likely to continue to support valuations. As a result, it is anticipated that core private infrastructure will continue to be robust over the upcoming year, providing investors’ portfolios with diversified and reliable returns.

All things considered

The economy and financial markets continue to face difficulties as a result of persistently high inflation and interest rate increases intended to combat it. In response, 2022 has seen increased volatility and widespread declines in publicly traded stocks and bonds.

As a result, the interest of investors in alternative investment strategies that could help diversify portfolios and protect against inflation risk has increased owing to this environment. Investors are also including the asset classes in well-balanced investment portfolios due to the fact that private credit, real estate, and infrastructure all continue to exhibit favourable characteristics when hedging against inflation.

Additionally, as they look to generate appealing risk-adjusted returns through market cycles, investors are increasingly putting their faith in global private markets managers who emphasise strong diligence, technology, fundamental analysis, and sector expertise. Overall, in times of economic uncertainty, investors look forward to the private markets in order to shield themselves against inflation and gain higher yield returns.

(Author is Cofounder and Managing Director, Oxane Partners)