Private markets are facing challenging times partly due to weaker global economy amid high uncertainty. Risks to the outlook are heavily skewed to the downside, with heightened chances of a hard landing.
Our Group Co-CIO, Michael Yaw Appiah, sat down for a Q&A session with Emma Nilsson, Zinqular Group for Media Director & Communications, to discuss state of private markets; macro trends; opportunities in the current challenging economic conditions; and the resilience in the global private markets.
The following is an edited version of Michael and Emma’s conversation.
Emma: There is a lot happening in private markets; what have you seen thus far?
Michael: Private markets enjoyed terrific tailwinds from the depths of the 2007/8 Global Financial Crisis through to 2H2021. The mood changed in early 2H2022 when banks began to pull back, unwilling or unable to lend. Private markets deal volume plummeted, performance declined, and valuations fell dramatically in certain sectors. Interestingly, private markets outperformed public markets.
// When we take a look at data from Zinqular research team, 1Q2023 Global private equity (PE) deal volume decreased 31% to US$2.9T from 2021, while deal count fell 18% to just under 56k. Total global private markets AUM spiked to over US$12T as of 1Q2023. Dry powder exceeded US$3.3T, reflecting an 8.4% YoY increase. PE multiples contracted as PE buyout entry multiples declined slightly in 2022/3, falling to 12.6x EBITDA from a record 13.2x a year ago, while public market multiples compressed dramatically, declining to 11.9x from 14.6x times EBITDA. Financial services fell −2.8x and information technology fell −2.3x recorded the largest multiple declines among PE subsectors, while rising commodity prices drove multiple expansion in raw materials and resources up +2.7x.
// Global PE performance turned negative for the first time since 2008, posting a −11% return through 1Q2023 and ending a 6-year run as the highest-performing private asset class.
Emma: What is the current state of play of global real estate and European commercial real estate (CRE) asset?
Michael: Global real estate (RE) deal volume declined 24% to US$1.3T, that is the second-highest year on record after more than doubling YoY in 2021, multifamily deal volume fell 32% in 1Q2023, accounting for nearly half of the asset class’s overall decline in deal activity. Real estate served as an inflation hedge – as institutional investors long-held belief in the asset class’s ability to protect real value during periods of higher inflation was firm. RE outperformed inflation in 6 of the last 7 inflationary periods, partly due to cap rate compression, interest rate hikes environment even in rising US Treasury (UST) rates. However, the pattern in 4Q2022 & 1Q2023 changed where cap rates fell and values rose; signaling heightened uncertainty across real estate markets.
// Looking at Zinqular internal data, we see that European commercial real estate (CRE) investment fell to its lowest in 11 years in 1Q2023; as investors worried by higher interest rates and the economic outlook put acquisition plans on hold. The number of office buildings sold – Europe’s largest real estate sector – fell to its lowest in history (since records began), while the volume of transactions slumped to a 13-year low of €10.8B. The UK kept its top spot as Europe’s largest CRE market, but Paris overtook London to become the region’s most active investment destination, with the three largest European property deals of the first quarter all taking place in the French capital. CRE has become a focus for fresh concerns about financial stability, after sharp interest hikes, recession fears and declines in office occupancy and retail footfall heaped pressure on values.
// European real estate issuers, meanwhile, have the equivalent of more than €24B due for repayment over the remainder of the year. We are definitely seeing real estate companies do all they can to “de-lever” – scaling back investment programs, more joint ventures, bond buybacks and where possible, dividend cuts. Disposals are a key focus too. Some recent comments from real estate issuers suggest it’s still not easy to sell large portfolios.
Meanwhile, in China US$139B corner of its credit market has been showing that smaller banks aren’t without some challenges of their own. Capital bond issuance by city and rural commercial banks during the first three months of 2023 plunged 70% from a year earlier.
Emma: How are private market investors like Zinqular responding to the uncertainty in the US commercial real estate (CRE) asset and how does it look in the future?
Michael: It is terrible to be an CRE office owner in America as prices fell in Q1 for the first time in more than a decade. The US vacancy rate for CRE office sub-asset class was nearly 20% at the end of the 1Q2023 and may get worst in the next few quarters as many office clients allow their lease to expire without renewal. At the same time, there is an imbalance in CRE markets with a severe lack of multifamily units, especially in fast-growing global metro cities but it’s impractical to convert the vast majority of offices into housing. We are going to see losses but the stresses will be concentrated and not systemic.
The US regional banks are over exposed to CRE as an area of concern while European banks have less direct exposure to the sector. US banks with less than $250B in assets account for 50% of commercial and industrial lending. US small banks account for almost 70% of all CRE loans outstanding. Almost US$1.5T of US CRE debt comes due for repayment before the end of 2025. The big question facing those investors or borrowers is who’s going to lend to them? Refinancing risks will be problematic for CRE investors/owners of properties from office buildings to stores and warehouses. Zinqular internal estimates shows US office and retail property valuations could fall as much as 35-45% from peak to trough, increasing the risk of defaults. The wall of debt is set to get worse before it gets better. Maturities climb for the coming four years, peaking at US$550B in 2027. In the US market, while there are obvious concerns about the availability of real estate finance following the banking turmoil in March, we’ve yet to see a widespread increase in distressed sales.
// Some asset managers saw their earnings plunge as the CRE slowdown stymied some their asset sales. Some also limited withdrawals from their real estate income trust after a surge in redemption requests. Rising borrowing costs are also squeezing property owners, complicating the financing for many buildings. It’s led landlords and asset managers to default on debt on purpose; as strategic step for re-negotiations with lenders. Some Realty Trusts are postponing their dividend payments until the end of the year, a move that surprised analysts and rattled investors.
We think as far as corporate credit goes; US investors are rushing to lock in the best yields on debt in over a decade; average US investment-grade bond yielded 5.1% as of 5th May. Our view is now is a good time to invest in company debt and that most of the credit downgrades to junk are already priced into the market. Zinqular portfolio refresh prefers to be at the top of the capital structure, investing in senior secured investment-grade debt. A good entry point for credit as liquidity has eroded, banking crises has further eroded it.
// Our message to clients is our exposure to the office building sub-asset class is zero. We have no exposure to that challenging sector. Broadly we are telling clients there are pockets of opportunities (multi-family housing, student housing, warehouse and datacenters) to invest in CRE and we are taking advantage of them.
Emma: We are hearing a lot that private markets are overvalued and that they should mirror public market valuations. Do you agree?
Michael: We don’t! By our experience we think private valuations cannot mirror public valuations. The makeup of private funds massively differs from that of public indices. As a fund manager, Zinqular, is focused in investing in businesses and assets that have consistent, sustainable, material and predictable earnings, usually with minimal capital expenditure or working capital needs (depending on that specific fund strategy). This focus can be largely attributable to the need to leverage these companies which facilitates our ability to garner relatively good equity returns for our investors. Consequently, predictable cash flows also allow Zinqular to effectively implement long-term strategic planning for these portfolio assets & companies without the potential impact of an unpredictable negative cycle causing disruption.
// Therefore, general PE portfolios are very much different from the broad public market indices, which encompass companies in industries which are highly cyclical and have greater exposure to changing consumer behavior or geopolitical risks. Reviewing data from open private market indices which measures changes in value of private companies, primarily PE-owned portfolio companies hence reflective of private manager portfolios; had exposure of only 13% to energy and consumer sectors combined as of 4Q2022, whereas the S&P500 weight to the same sectors was nearly 27%.
// Another debate is the difference in the mix of industries between companies in PE portfolios vs. the public markets accounts for part of the difference in the volatility of their valuations. Zinqular and private markets in general are less influenced by capital flows. Greater public market volatility can also be attributed to the influence of capital flows that rarely, if ever, impacts private markets. Large institutional investors and sharp changes in retail investor sentiment, can cause dramatic swings in valuations. Within moments, public company valuations can fluctuate due to portfolio-level decisions that may be completely unrelated to the fundamental performance of a particular company. Private managers on the other hand, have access to large and growing capital pools that are either permanent or locked up for extended periods, usually over 5 to 6 years. This capital pool (i.e., dry powder”), is used for an array of solutions for private companies including, but not limited to, infusing capital for future growth and shoring up liquidity shortfalls that might present themselves over time. This pocketbook of cash, unredeemable by investors in most cases until the end of a fund’s life, insulates private companies from changes in valuations caused by the market sentiment of investors, who may be making investment decisions on issues unrelated to a specific company, such as diversification issues or capital needs, and at times make irrational or uneconomic short-term decisions.
// We are also practical. We know trends in public markets can eventually trickle down to private markets and lead to both two markets correlating. But private markets have historically demonstrated less valuation volatility compared to public markets. Generally, while private market valuations may not see the dramatic declines seen in public markets, they often also do not participate in the outsized positive returns public markets have over shorter timeframes.
At the onset of the 1Q2020 pandemic, the Morningstar LSTA US Leveraged Loan Index, which is an index of broadly syndicated public loans, sharply declined by 14.3%. In contrast, some average Private Market Senior Debt Indices, which measures changes in fair value of senior privately held debt investments, fell by only 5.6%. However, by the end of 2020, both declines had almost entirely retraced, with the two indices lower by only 0.6% and 0.4% for the year, respectively.
Another instance of divergent short-term trends showed in equity markets in 2022, when the private market indices increased by 4.8% while S&P 500 enterprise values (EVs) fell by 18.4%. However, through 2020 and 2021, S&P 500 EVs materially outpaced private market indices. While 2022 performance could be viewed as a short-term divergence it can also be interpreted as a long-term convergence, with S&P 500 EVs falling back to the private market indices and below during the year, then rebounding to converge again at year end.
Emma: There is a school of thought that PE valuation processes lack objectivity and transparency as some fund managers do not update fair value inputs, which inflates values compared to public counterparts. What is your take on that?
Michael: I think it is a misunderstanding to suggest that PE managers valuation processes are biased. Certainly after, the 2008/9 great financial crisis (GFC), the 2010 Dodd-Frank Act, and EU financial regulatory directives; PE and credit valuations are subject to extensive oversight from board of directors and audit committees, auditors, regulators, investors and other interest parties. This results in a high standard of accountability. Private asset managers take measured steps to ensure compliance with ESMA directives, SEC rules and U.S. GAAP, with many large firms employing dedicated internal resources specifically to valuation rather than using deal teams to oversee the valuation processes.
// For instance, there is the ubiquitous and continuing regulatory focus on valuation, the SEC’s 2023 SEC Exam Priorities explicitly lists compliance with “Investment Company Act Fair Valuation Rule 2a-5”. In addition to many techniques for asset valuation; good faith fair value determinations continue to be top of mind for private managers, regulators, auditors, boards, general partners (GPs), limited partners (LPs) and other overseers.
Zinqular have independent internal valuations team that prepare valuations without the bias deal teams may have. Next, we utilize third-party valuation firms that provide the manager with their views on valuations. Managers that deviate from the recommendations from these third-party firms normally need to justify these decisions to their valuation committees and auditors. In addition, board valuation committees and auditors regularly review these marks to ensure best practices have been followed and that the marks adequately reflect a company’s performance and market conditions.
In addition to regulatory scrutiny, our clients, the LPs; have placed increasing focus on valuation transparency and conduct regular due diligence to ensure GP processes align with fair value accounting standards. The resulting structure is a checks and balances system in which LPs continuously review GP valuation procedures. LPs regularly request valuation reports to gather insight into the conclusions and fund managers are responsible for clarifying any outstanding questions from investors. These trends have resulted in the increased use of 3rd-party valuation firms, which further buttresses the credibility of PE and credit valuation processes.
Data from regulatory filings of publicly traded PE and credit funds suggests over 68% of managers indicated they selected lower EV multiples for their portfolio companies and the average multiple decline in the sample was approximately 0.6x of EBITDA. In addition, during the period from Q2 2021 through Q4 2022, the LPMI showed seven consecutive quarters with multiples declining, yet the index actually increased during that period due to steadily improving operating performance.
Emma: How do you respond to those that say – leveraged capital structures lead to conflicts of interests amongst PE sponsors and lenders that can create negative outcomes and lower valuations for private portfolio companies.
Michael: Again, it is misconception to impute conflict of interest between PE sponsors and other parties in aforementioned. Generally, public company capital structures are often comprised of complex financial structures with multiple tranches of debt and equity, all provided by numerous disinterested parties. These stakeholders, such as bond holders and equity holders, often have disparate priorities wherein a bond holder’s goals are primarily focused on recovering principal and interest payments and rarely focused on the next deal nor the strength of the relationship with the equity group backing the company. As a result, economic interests can quickly diverge (and they often do) based on several factors such as market sentiment and company-specific circumstances. For instance, if a public company requires additional equity, there are few places to turn and it is unlikely that shareholders will closely coordinate with each other or bondholders to achieve a mutually beneficial resolution. Bondholders often shift their focus to recovery of principal and exiting their position as a whole. This divergence of interests, alone, often attributable to the swings in sentiment that creates significant volatility to the firm’s public valuation.
// In private markets, it is increasingly common for PE sponsors to use the private debt markets as opposed to the broadly syndicated debt market to finance their transactions. As a result, these structures have fewer lenders, which simplifies negotiation processes if portfolio companies experience headwinds or require access to additional capital to fund growth. This is also facilitated by the increasing prevalence of unitranche financing structures, which results in even simpler capital structures and fewer conflicting interests amongst lenders, allowing for less complexity and quicker solutions. Additionally, PE relationships have become invaluable to lenders on the back of increased competition due to the large influx of capital to the private debt market, which should lead to more constructive and creative solutions in difficult situations. Many lenders evaluate PE sponsors and funds as part of underwriting processes, with each vetted by lender investment committees. In many circumstances, relationships can make or break deals and, as such, have become an essential consideration for lenders.
Due to small number of lenders and equity holders supporting a PE portfolio company, they are able to closely monitor each company, predict its needs and take the necessary actions to effectively ward off any dramatic swings in performance before it even happens, thus mitigating changes to valuations.
// Looking at 2022, the disconnect between private and public valuations and returns was questioned by the media and some observers. The reality is that fundamental structural differences afford PE and credit investors a degree of stability, which is expected to persist through future periods of uncertainty as it has in past periods of uncertainty. Looking ahead, we expect that while private markets may experience similar economic challenges to public markets, they will retain the characteristics described throughout, that should lead to less volatility but general alignment with public market valuations.
Emma: What is Zinqular’s approach to portfolio construction prelude to uncertain economic regimes or when regimes are ambiguous?
Michael: Broad sector compositions in different vintages of Private Equity funds are often more dynamic than those of public markets. To answer your question, I will say it all depends on fund strategy. Are we looking at Traditional 60/40 or Alternative Enriched 30/40/30 or Alts Enriched +PE 40/30/30 or Alts Enriched +PE 25/30/45, etc.?
// For portfolio construction there are some models we look at. Some investors typically build regime specific portfolios by using parameters such as fund strategy plus observing past periods in which such a regime prevailed based on a single indicator and a fixed threshold, and by using estimates of expected returns, standard deviations, and correlations by averaging their values during these periods. This conventional approach of equally weighting observations from past regimes assumes that a regime either occurred or did not occur unambiguously and that each period is equally relevant to assessing asset class behavior in a forthcoming regime whether the regime indicator was only marginally beyond the regime threshold or far beyond the threshold. This binary view of a regime is also problematic because there is no non‐arbitrary way to combine more than a single regime indicator to define a regime and because it precludes the anticipation of regimes that have not occurred historically.
// A better resilient model we think is to use a statistic called relevance to estimate asset class expected returns, standard deviations, and correlations. Relevance measures two components, similarity and informativeness. This nonbinary description of regimes also enables us to define regimes based on the co‐occurrence of multiple indicators in a way that is theoretically justified, and it allows us to contemplate regimes that have not occurred historically but are nonetheless plausible looking forward.
Our experience shows that timing effect of deployment and exits can also bolster performance when done systematically. For instance, an institutional style alternative enriched portfolio (i.e., Alts Enriched +PE 20/[60]/20 portfolio) composed of 20% public equity; [20% private equity; 20% Infrastructure; 10% Real Estate; 10% Private Credit] and 20% Bonds achieved incremental excess returns versus the 60/40 over all periods, which is significant if we are right that we are entering a lower return period for most asset classes.
Emma: What your thoughts about the current US regional banking crisis? Is the worst over or there is still more to come?
Michael: The banking crisis has claimed 4 US lenders thus far this year and stuck investors with more than US $54B of losses, after First Republic Bank’s demise added piles of nearly worthless securities and sent some peers into new tailspin. The tally includes $46.9B of market capitalization erased since Feb. 28, just before the bank turmoil began in earnest, and about $7.5B gone from bonds and preferred shares. It is a stark reminder of how quickly financial companies can collapse, and that they leave little to compensate stockholders or debt owners, who stand at the back of the line for recoveries.
// Our view is the current crisis of confidence in US regional banks is not over, as many banks continue to suffer from: 1) losses on their securities portfolio, 2) a drop in the value of their loan book, 3) heavy exposure to the ailing commercial real estate market and 4) potential huge deposit withdrawals. Many are still unable to offer clients attractive enough interest rates to prevent a depositor flight to more profitable and ultra-safe money market funds.
The resulting credit crunch will tip the U.S. economy into severe economic contraction later this year, as the Fed is ill equipped to deliver both on its dual mandate of low inflation and maximum employment while rescuing banks.
// US banks are sitting on excess of US$620B of paper losses due to the rise in interest rates per US Federal Deposit Insurance Corporation data while data from NYU Stern School of Business suggest losses as high as US$1.7T, which is comparable to the total equity in the entire banking system. The US Fed has over US$1T unrealized loss on Treasury/MBS holdings with still more to come in the next few quarters.
How did we get here? Torrents of money printing have turned banks into “drug addicts” reliant on cheap cash to stay afloat. Decade of ultra-low rates and repeated rounds of quantitative easing (QE) encouraged lenders to take bigger risks in search of returns that are disappearing in the world of higher interest rates.
When the “cheap money” is withdrawn amidst high rates and falling MBS values then suddenly banks business models fail. How and why did these systemic risks emerge? Our view is the root cause of these systemic risks is monetary policy.
We are offering pension funds, insurance firms, etc. the possibility to have a balanced portfolio with alternatives and varied hedging from the current or future economic turmoil. Generally, private markets such as alternative asset classes outperform the markets in times of economic stress.
Emma: The current geopolitical tension between China & the US is leading to a new cold war. How will it affect the global economy in the near term?
Michael: Without a doubt, a new cold war between America and China threatens to “carve-up” the global economy and fuel painful stagflation in West. We think the two superpowers are in the process of extricating themselves from mutual interdependencies that are increasingly seen as security risks. America is tearing apart existing trade routes and building new ones with its closest allies, China on the other hand, plans to insulate itself from potential western economic sanctions by gradually decoupling from the U.S. dollar. We’ve gone from free trade to “protectionist” trade, from offshoring to near-shoring, from just-in-time supply chains to just-in-case. These things are costly, they reduce global growth and increase cost of production.
// After the collapse of the West’s last systemic rival, the Soviet Union, the resulting “International Peace” overseen by America ushered in an economic boom based on the primacy of free markets, liberal democracy and the rule of law. Multinational corporations could arbitrage the best of a country’s competitive advantages, whether that be research and development or cheap and plentiful labor, driving down their manufacturing costs as part of the deflationary trend toward globalization.
In the process, however, these ensuing economic linkages created a web of interdependencies that now mean China is the dominant supplier of critical resources like rare earth magnets, refined lithium and monocrystalline silicon, which are needed for the green and digital transformation. The West is also reliant on Taiwan as the sole supplier of its most advanced logic chips, forcing it to arm the small island nation to deter a possible invasion by its larger neighbor across the strait.
Emma: How does commerce suffers from unwinding efficient global supply chains? How does change the discussion of the world’s reserve currency?
Michael: The current geopolitical tension is breaking the economic links with systemic rivals like China and Russia will certainly lead to less efficient commerce through the “unwinding” of global supply chains. Meanwhile China has negotiated with Russia to buy its oil and gas without resorting to the US dollar as a means of exchange—cutting the U.S. entirely out of the equation in the process.
We think losing reserve currency status exposes US to its twin deficit’s challenges. Establishing the yuan as the second global reserve currency would give China more protection against economic retaliation should it seek to expand through military means much like Russia. They’re worried that the kind of sanctions US and it’s a allies imposed on Russia—if there was a conflict or escalation over, say, Taiwan—could be imposed on China; which as over a trillion dollars of reserves that are in dollar. Therefore, they need to have an alternative account, a means of payment, a store of value, that is an alternative to the US dollar.
// The rise of the yuan would be bad news for Americans, who are only able to finance their consumption thanks to the willingness of other countries to constantly buy U.S. dollar-denominated assets like Treasury bonds. Should it no longer be the issuer of the world’s sole reserve currency, the U.S. would find itself competing with China as a haven for excess foreign capital. Borrowing costs would rise and Americans would no longer be able to enjoy the same lifestyle they do now. That will mean less financing of their own twin fiscal and current account deficits, when we still have very large stocks of private and public debt – pushing high the cost of financing for America.
// It is quite difficult to displace a reserve currency. It takes time and something that happens gradually. Our view is the dollar as a reserve currency is not coming to an end any time soon instead the world will transition to “bucket” of mix reserve currencies i.e., multicurrency polar regime. The de-dollarization movement is gathering global momentum, with an increasing number of nations from Asia to Europe and Latin America lining up plans to end the greenback’s dominance of global trade and investment flows. China, for one, has implemented new transaction methods for its yuan, such as by using swap lines, and the nation has also strengthened its ties with other economies to move away from trade in dollars.
// First, the rapid growth of central bank swap lines engenders confidence that yuan can be obtained from the Chinese central bank. Second, the proliferation of offshore yuan markets reassures central bank reserve managers and other investors that they can convert yuan into dollars/euros at stable and predictable rates. Recent agreements between China and Brazil, China and France, and India and Malaysia, to settle trades in one another’s currencies, while French president has urged Europe to wean itself off its dependence on the greenback. Since 2009, the Chinese Central Bank, has negotiated bilateral currency swap agreements totaling RMB3.7T (US$550B) with at least 39 central banks. Since 2010, when yuan trading in Hong Kong was first authorized, offshore markets have sprung up in 24 other cities around the world. By July 2021, RMB1.25T (US$200B) was deposited in offshore accounts — an order of magnitude smaller than offshore dollar deposits.
// The BRICS currency union when launched will be poised to achieve a level of self-sufficiency in international trade that has eluded the world’s other currency unions because BRICS members would likely be able to produce & trade a wider range of goods than any existing monetary union.
The USD is losing its market share as a reserve currency at a much faster rate than is commonly believed. It’s true that the dollar now accounts for a smaller share of international reserves than it did in 1999 — down over 70% then to 59%. However, if you take review the data back to 1995, you can see that the dollar share of international reserves is higher today than it was back then. Chinese yuan remains such a small share of international reserves due to “capital controls”. We think without capital controls, a very large amount of Chinese capital would leave the country in search of diversification and more secure property rights.
Emma: There are waves of US bankruptcies and unusual economic stress happening more than we have witnessed. Are we at the bottom? How will things play out in the near term?
Michael: America has a “very complex” economy. One would not know it from looking at the S&P 500, but there is a bit of a bankruptcy crisis sweeping the US and many parts of the western economies. For instance, US firms are filing for bankruptcy at the fastest pace in 13 years in part due to credit tightening plus financial markets have locked out all but the strongest borrowers. The increase is most visible among large companies, where there were 236 bankruptcy filings in the first four months of this year, more than double 2022 levels. There were about 16,200 bankruptcy filings among all types of companies in U.S. District Courts in 1Q2023 – up from 12,200 a year earlier.
// What we are seeing is that US middle market companies are under tremendous pressure. We think we’re seeing and going to see a lot of bankruptcies. For instance, VICE Media; Bed, Bath and Beyond filed for bankruptcy quite recently; we got Walmart not only laying people off, but closing stores and other assets such as their Technology Hubs. We got Accenture, Meta, Google, Linkedin, financial services firms, etc., laying people off. We got Amazon laying 1000’s of people off and closing distribution centers. So, we think there’s a strong-mixed message.
Looking at Zinqular’s internal data, we believe more than 50k US retail locations could permanently closed over the next three to five years. Those closures would cut the current U.S. store count of about 940k by around 7% by the end of 2027. The number of closed stores is “already up significantly” in 2023 compared to last year, due to heavy hitters like Bed Bath & Beyond, Foot Locker and other notable firms trimming their footprints.
// Over the past year, more retail firms have initiated a turnaround plans that involves shuttering hundreds of stores. Few weeks ago, Foot Locker announced it plans to close more than 400 low-performing stores in shopping malls by 2026 as it shifts its focus to new concept stores.
On a broader political level, US Congress’ inability to come together and raise the debt ceiling limit has placed an unprecedented burden on businesses. We are seeing tremendous inventory buildup in a lot of the businesses, both public and private.
Our view is the economy and the market will bounce back eventually.
Emma: Looking ahead where do you see the greatest investment opportunities in Europe & the US over the next decade?
Michael: Over the past three decades, a sustained surge in inflation (and high interest rates) has been absent in public and private markets. As a result, investors face the challenge of having limited experience and no recent data to guide their portfolio construction or repositioning of their portfolios in the face of heighted inflation risk. When we look at the data, combine them with other parameters; we think the following asset classes will do quite well in the next decade.
// First, we see broader mandate for decarbonization, infrastructure & natural resources in the next 10 years. Infrastructure sits at the heart of the transition to a low-carbon economy and the urgent near-term need for energy resilience. We are drawn to niche opportunistic green infrastructure for its reasonably high excess returns and inflation-mitigating return characteristics. We believe the global transition to a low-carbon economy will need US$125T of new investments by 2050 – represents a major opportunity for infrastructure investors around the world. However, macroeconomic events may have mixed impact across sectors; for e.g., rise in oil and gas prices may drive resurgence in demand for traditional energy investments amid the multiyear push toward decarbonization. Sustainable investing (i.e., ESG) will gain massive scale for instance, from 1Q2022 to 1Q2023, deals increased by 9% to nearly $230B, proving resistant to the deal-making headwinds that affected other asset classes. The “E” part will lead the sector with power and transportation sub-sectors dominating allocations. ESG growing impact on private markets now goes beyond just dedicated funds and deals.
// Private Credit asset class offers unique advantages in an environment of rising rates, inflationary pressures and economic uncertainty. The increase in interest rates in many countries has caused turmoil in the capital markets. But certainly, a boom in private credit due to flexibility of capital to react to changing market conditions. Private credit can offer greater certainty of higher levels of contractual cashflows as well as other features that can potentially help hedge the effects of economic turbulence on other asset classes. The amount of dry powder in both PE and private credit – more than US$1.25T 1Q2023.
// Commercial real estate (CRE) and Residential real estate (RRE) are in a state of adjustment, as the drivers of tenant demand shift markedly and investors adjust their portfolio allocations. We are seeing widening gap between sectoral winners and losers. As interest rates and inflation rises, indexed rental leases can offer an important hedge. Higher rates are inducing distress for unhedged owners and discounts for ready buyers. The following will do well – green data centers, multifamily, industrials and senior housing.
Emma: Thank you for your time.
Michael: My pleasure.
The End