investment insights
Are clouds lifting for private assets in 2024?
Private Bank
Key takeaways
- Early signs of a recovery in private equity dealmaking should create opportunities for stronger managers to outperform, after a reset in valuations in 2023
- The end of rising interest rates will put some pressure on private credit, but we see ongoing strong performance, diversification benefits and contained risks after rapid recent growth
- Macroeconomic headwinds and falling valuations in real estate markets could create opportunities in distressed assets. Infrastructure funds are experiencing secular tailwinds
- For clients with an appropriate risk profile, our ‘total wealth’ portfolios include private assets, with a view to achieving diversification, enhanced returns, and lower volatility.
High interest rates and a lack of corporate mergers and acquisitions have delivered a tough 18 months for many private asset classes. What can investors expect in 2024?
Private equity – the largest share of the private assets market – suffered in 2023. Rising interest rates and geopolitical and macroeconomic uncertainty led to deals drying up and slowed the flow of returns to investors. Selling activity has fallen to its lowest point in over a decade. This has also affected fundraising, which fell to an eight-year low in 2023. Private equity firms are now sitting on a record USD 2.8 trillion in unsold investments and an additional USD 2.6 trillion in uninvested cash1. Such a drag on the sector is unlikely to be unwound quickly. With valuations marked down and little distributed capital, some areas of private equity are likely to have underperformed public markets last year.
Will 2024 be any different?
Private equity managers were forced to mark down portfolio values in 2023. Slowing growth and still-tight credit conditions will continue to weigh on corporate activity, and particularly appetite for striking big deals. We expect fundraising to remain challenging in 2024. But a surprisingly resilient US economy is keeping credit risks contained. In the second half, interest rate cuts in developed markets and a declining cost of capital should create an improving backdrop. Our base macroeconomic scenario remains a soft landing for the global economy, and further falls in inflation.
There are already some tentative signs of recovery for private equity. Deal value globally rose 58% in the fourth quarter of 2023 on the prior three months, according to data provider Preqin. Private equity managers report more encouraging deal flow and a relatively strong pipeline of opportunities. Nasdaq and New York Stock Exchange executives report many more companies filing for listings in recent months. All this suggests a potential for increased liquidity and activity in 2024.
As private equity’s uninvested capital has continued to build and interest rates have stabilised, sellers’ and buyers’ expectations should converge more, leading to an increase in deal volume going forward. The technology sector – powered by small company innovation in artificial intelligence, cloud computing and certain emerging markets – is also providing new opportunities.
The industry has also found new ways to finance deals and investor distributions. These include borrowing against portfolio company cashflows, selling stakes to secondary funds, or creating ‘continuation’ funds2 for the same purpose. With pressure for liquidity building and continuation funds now making up roughly half the market for secondary sales3, it could be a strong year for investor allocations to these strategies.
The importance of manager selection
Lower valuations across private equity, particularly for venture and growth capital funds, are creating opportunities for those with capital to deploy, and those with a focus on distressed assets. Private equity funds that launched in difficult markets have historically performed well, according to data from Cambridge Associates.
Both public and private equity markets were marked by unusual concentration in 2023, with large, well-established managers raising the lion’s share of funds. We expect this to continue, driving an industry consolidation and underscoring the importance of manager selection for investors. The difference between the best and worst performing managers for 2009-2019 funds was 18 percentage points, estimates McKinsey, highlighting high performance dispersion within the asset class.
Can private credit’s remarkable growth continue?
An uptick in dealmaking this year would also help private credit, or non-bank loans to mostly unlisted companies. 2023 was a bumper year for the industry, with a record number of funds in the market, and the largest ever loan, of USD 5.3 billion. Assets under management in private credit are now close to USD 1.3 trillion, estimates Moody’s, roughly the size of the global high yield bond market. The retreat of banks from corporate lending explains part of this remarkable growth. Private credit markets have also been driven by investors’ desire to capitalise on rising interest rates, since rates on private loans are usually floating, and offer higher yields than coupons from comparably rated public bonds.
In 2024, we expect falling interest rates to pressure private credit returns. But appetite from investors and asset managers to branch into the asset class remains solid. Private credit returns are not correlated to market sentiment and can hence offer stability and diversification benefits.
Concerns over the industry’s rapid rise, and its fate if the economy slows and default rates rise, warrant close monitoring. However, we think these risks look manageable, since private loans are typically secured against the borrowers’ assets, while default rates remain contained for now.
Commercial real estate issues
Many areas of private real estate have struggled since the pandemic. Bank funding and capital available for deals have shrunk amid investor caution and commercial real estate stresses. Valuations may fall further. Yet macroeconomic headwinds could create opportunities for buyers of distressed assets, while some areas (logistics, data centres, student housing) are enjoying structural growth. Supply is falling – particularly in office markets – which could, in the longer-term, lead to a recovery. In the meantime, inflation-linked rents provide a hedge against rising prices.
Meanwhile, infrastructure funds are seeing strong secular tailwinds. Most developed economies need to significantly increase investments in their infrastructure, old and new. Governments will not be able to shoulder the burden on their own and the private sector will be a key driver of this capital expenditure. Infrastructure now dominates real asset fundraising, as sustainable energy and digital infrastructure projects draw capital away from the old leader, oil and gas. Infrastructure’s resilient cashflows, which are less dependent on the economic cycle, can make it an interesting addition to portfolios.
Long-term opportunities and our ‘total wealth’ approach
Of course, investors in private assets should be aware of the risks involved, and the constraints of locking up capital for several years. For investors with an appropriate risk horizon, our ‘total wealth’ approach combines public and private assets within a portfolio, with the aim of achieving diversification, enhanced returns, and lower volatility. Research suggests that the best private equity investments have historically outperformed public markets. This is reflected in our own, forward-looking 10-year return expectations.
Private assets are also benefitting from secular tailwinds, including banks stepping back from some forms of lending and firms staying private for longer. More than half of all US companies with over USD 1bn in revenue are privately owned, estimates Preqin. It forecasts the private assets industry to grow 10% annually for the next five years. Private capital remains less than 5% of global financial markets, implying significant scope for expansion. We see opportunities here and favour multi-year investments across a range of private assets, with a focus on identifying, and accessing, the strongest managers.
1 Sources: Bain & Company, Standard & Poor’s
2 A continuation fund transaction is a specific type of secondary transaction, which involves private equity managers selling one or more portfolio companies to a newly formed continuation fund that they also manage, and which has been formed for the purpose of acquiring the portfolio companies.
3 Source: Goldman Sachs Asset Management
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