Private markets shine against backdrop of high inflation
The spectacular and still rising surge in global inflation has forced investors and companies into a wholesale re-examination of practices, policies, and procedures across the investment lifecycle. After more than a decade when inflation remained largely subdued, today the situation is an abject horror-show with a perfect storm of supply shocks and the release of pent-up demand propelling price indices up faster at double-digit rates.
Institutional investors are asking themselves what comes next, and how will this affect private markets?
Our view is that the significance of private markets to institutional investors is going to continue to expand over the coming years as we adjust to higher inflation. In addition to this, we expect ever greater attention to be paid to questions of efficiency and how to increase it in private capital markets.
Private markets in a high inflationary environment
Contrary to the past decade where other factors took prominence, inflation currently represents the most significant threat to conventional investment strategies.
According to Invesco’s Global Sovereign Asset Management Study, there isn’t yet consensus on what direction inflation will go from here. Roughly 40% of the 139 respondents surveyed expect inflation to remain high for the next two years, and this is matched by approximately 40% who expect it to gradually fall back towards 2%. Most worryingly, nearly 20% anticipate stagflation, the pernicious combination of high inflation and low growth last seen in the 1970s.
Where there is consensus, however, is the view that taming inflation take time and will almost certainly necessitate further aggressive rate rises from central banks. This combination of sustained inflationary pressure with rate rises and generally tighter monetary conditions constitutes a radically different macroeconomic environment, and allocators are accordingly rethinking their approaches.
Given their hard-earned reputation as inflation-hedges, it seems probable that alternative assets will have a growing role to play in this new context. Within this overall category, private markets offer one of the best opportunities to outrun inflation.
The post-2008 bull market is definitively over
In the years following the 2008 crash, inflation remained generally benign. Central bank action staved-off the threat of recession becoming depression, and the development of new monetary tools proved effective at rekindling demand in the short-term.
However, the massive monetary stimulus stoked an unprecedented round of asset price inflation, with valuations reaching and then breaking records again and again for indices like the S&P 500 and the Nasdaq 100. Passive investing accordingly flourished, with low-cost index trackers highly likely to have outperformed active strategies in these years.
It was during this phase that pension funds and other large institutional investors started to pay more attention to private markets. With indices soaring higher and higher, and bond yields crushed under the weight of central bank buying, the need to allocate more to private markets became apparent. While private markets had known issues – chiefly, but not exclusively, the lack of ready liquidity – the pressure to generate higher returns than those available simply by piggybacking on the major indices forces many institutions to up their allocation to private markets.
Today, public markets look unappealing for a different set of reasons, and private markets are again back in focus as a potential source of inflation-beating returns.
Alternatives are no longer optional
Global private capital AUM sat at just over $4 trillion in 2015. This had swollen to nearly $9 trillion by 2021, and forecasts from Preqin expect this to rise to a staggering $23.21 trillion by 2026. As the graph below shows, private market assets represent the largest component of the overall alternatives universe, and their growth is predicted to be the most dramatic.
An example of this is the fact that public-to-private buyouts are increasing today at the fastest rate since 2007. In 2021, the total value of buyouts taking public companies private stood at $118 billion. The comparable total for the first half of 2022 had already reached $96 billion and will soon have surpassed the 2021 total.
Investors’ appetite for take-private buyouts of listed companies is symptomatic of the enhanced role private capital markets will increasingly play over the coming years. As inflation erodes the real value of the income generated by bonds, and rising rates keep public markets firmly anchored, private markets will become a more and more essential part of institutional portfolios.
Why can private markets potentially offer inflation-beating returns?
First and foremost, private companies can take a more long-term view than their public competitors. Listed companies must endure intense quarterly pressure to maintain revenue and profits, often preventing management from focusing on long-term issues. This means private companies are potentially better placed to strategically reposition themselves when directions change.
Similarly, unlisted companies could also be better set-up to take advantage of the myriad opportunities to develop and implement low-carbon tech across the economy. Public companies, again due to the relentless short-term pressure to keep shareholders happy, are less likely to stomach the extensive capital expenditure needed today to create the preconditions for environmentally friendly profits tomorrow.
As fixed income assets continue to decline as a share of institutional portfolios, private market and other alternatives are expanding to take their place. With expectations of persistently high inflation starting to become anchored, these changes to allocations are likely to be fixed for at least the next few years. A positive corollary of these rising allocations to private markets is that as liquidity increases the so-called illiquidity premium should logically decrease, further encouraging more investors to diversify into private markets.
Bringing efficiency to private markets
It is apparent that the significance of private markets to institutional investors is going to continue to expand over the coming years as we adjust to higher inflation.
However, this means that the need to solve the inefficiencies and barriers to entry that limit participation in private markets is all the more pressing.
Technology will be key to overcoming these problems and unlocking the potential of private capital markets. By streamlining, simplifying and accelerating the time- and labour-intensive processes involved in both primary and secondary private market transactions, digitisation and automation have the ability to increase the exponentially efficiency of private markets.
At Globacap we’ve enabled frictionless and vastly more efficient origination and distribution of digitised assets than ever before possible.
Through our private placements and secondary liquidity solutions, Globacap has brought public markets style infrastructure to the private capital universe. In this way, with efficiency and cost-savings being unlocked across the entire investment life-cycle from origination to clearing and settlement, the efficiency gap between public and private markets will continue to diminish.