What to expect from private markets in 2023
2022 will be remembered for many things, but the dramatic falls in public market valuations are highly likely to be at the top of the list. With expectations now anchored for a deep and protected recession in 2023, the only debate taking place is how severe it will be and how long it will last. In this context, institutional investors are raising their allocation to private markets in anticipation that returns here can offset volatility in listed equities. Here at Globacap, we have a unique perspective on these trends as we work extensively with exchange groups and private markets investment managers. We take a look ahead and make a few predictions for private markets in 2023.
Higher inflation is here to stay
The news that UK inflation has fallen back towards 10% has been positively received; however, the fact remains that investors are braced for significantly higher inflation to be part of the landscape for at least a year to come. With the Bank of England’s November report forecasting elevated inflation in the region of 10% for much of 2023, investors are left with no choice but to hunt for higher expected returns. This means the decision of how to allocate between traditional securities (bonds, stocks, ETFs, mutual funds), and more risky alternative assets is more urgent today than ever before. As we head into 2023, institutional investors and retail investors alike can be expected to keep increasing their exposure to alternatives in the hope of outrunning inflation over the next 12 months. The recently published SS&C Intralinks 2023 LP Survey has shown this trend to be a key concern for LPs looking ahead to next year and pre-planning their allocation strategies.
Recession years often produce strong returns for private equity
Alongside higher inflation, the rise of recession in Europe, the US and the UK remains high. However, statistically speaking many private equity investors will already be aware that recession years have tended to produce high-performing private equity funds in the past. A 2023 recession may therefore represent a great opportunity to add to investments in this space.
As the chart shows, funds raised in recession years have tended to outperform funds raised at other points in the business cycle. A potential explanation is that recessions represent the best possible opportunity to buy good assets at great prices, prices which subsequently rise when the economy recovers.
Which mega-trends are set to gather pace?
Private assets are inherently long-term – or at any rate longer than their listed counterparts. However, secular concerns inevitably influence the type of assets and strategies in favour at any particular time. The overarching social and economic mega-trends in support of private assets have rarely if ever been as favourable as they are today.
The broad consensus is that climate change requires vast adaptions to existing structures of production and consumption, as well as the creation of whole new industries and sub-sectors. Dissent from this view is much rarer today than was the case even just 10 years ago, and means more and more private capital is being willingly allocated towards sustainability-focused enterprises. Generating, scaling, and finally implementing these new technologies is a highly capital-intensive process.
Blackrock expects the global transition to a low-carbon economy to require at least $125 trillion in new investment by 2025, and this represents a massive opportunity for investors willing to allocate their capital over a long-term cycle to such endeavours. This suggests that a great deal of the dry powder built up over the past few years will be able to be deployed with private companies working on the great medium- to long-term challenges facing society.
Demand for secondary liquidity to continue rising
We’ve already talked about liquidity and how important it has become for public and private markets this year. With public markets occasionally displaying what could be termed ‘excessive liquidity’ – see the September meltdown in UK gilts caused by fire sales of these supposedly safe assets – there is now debate about what level of liquidity is appropriate for different asset types. This debate was given further impetus by the decision made by Blackstone to limit withdrawals from its flag-ship REIT in November, and today the issue of how individual assets and even whole portfolios score on liquidity is near the top of investors’ minds.
In private markets, where assets have typically been long-term and illiquid, demand for secondary liquidity has never been higher. Importantly, this demand is spurring the development of technological and financial solutions which can make this desired liquidity a reality. Whether through digitisation, automation, the creation of new trading venues, or even new protocols for trade settlement, the influx of institutional and retail investors into this space has driven higher demand for secondary liquidity, and this has led to rapid progress in making the previously illiquid, more exchangeable. This has undoubtedly been a major theme of 2022; we expect this to continue to gather pace in 2023.
Less correlated returns desired
The collapse of valuations in both public and private markets, albeit with a time lag muffling the impact from the one to the other, has re-energised the search for genuine diversification. Whilst the classic 60/40 portfolio, split almost equally between stocks and bonds, would once have been enough diversification, the emergence of various risk-off scenarios when both stocks and bonds fall in tandem has meant this may no longer be sufficient. Instead, alternative assets have grown to claim a larger and larger share of the average institutional portfolio.
However, even here correlations are emerging that reduce the hedging ability of some alternatives. An asset class which can offer genuinely uncorrelated returns, and therefore provide a significantly better hedge for stocks than either bonds or alternatives, is insurance-linked securities (ILS). With returns on such securities driven by events in the natural world and the probability that insurance firms have to pay out on insurance contracts designed to cover natural catastrophes for example, ILS can provide steady returns with no correlation at all to events in the wider markets, either public or private. We agree with Artemis and expect to see more ILS appearing alongside and in complement to private assets in large portfolios in 2023.
Infrastructure and unlisted real assets rise in stature
Finally, unlisted infrastructure looks set to draw in ever higher flows of capital next year. Crucially, with inflation forecast to stay stubbornly high throughout 2023, investors are increasingly attracted to assets whose connected cashflows have some sort of inflation linkage built in.
Themes like improved cloud and data infrastructure, more sustainable energy generation, and upgraded transport networks will continue to require large amounts of private capital to expand, and usually these real assets generate cashflows that are indexed to inflation. Russell Investments expect to see real assets continue their rise in popularity as we head into 2023.