As asset values fall, there is the potential for vintage returns to be generated once market dislocation settles down. For example, research[1] indicates that in aftermath of a downturn, private equity investments consistently outperform long-term average returns.
2022 was a particularly tough year for investors with a traditional 60:40 equity/bond portfolio down as much as 17%, as both equities and bonds plunged[1]. The longstanding asset mix ratio has been under question for some time as performance has showed more correlation (and thus less diversification) than is ideal for those attempting to construct an optimally risk-adjusted portfolio. In tandem, the rise of, and access to, alternative investments has meant private investors have been allocating an increasing proportion of their portfolio to these strategies as they seek greater diversification from public markets.
Private investors may not be allocating as much of their portfolios to alternatives as institutional investors (where the average is 30%[2] - a level at which analysis has shown that returns are enhanced and volatility reduced[3]), but a substantial proportion are not far behind. Recent research among our private investor clients found that almost one in three of responders are now allocating 25%-plus to alternatives.
So, what kinds of alternative investments are private investors most interested in currently, and what opportunities have been created from the macro events of 2022? After all, every cloud has a silver lining. As asset values fall, there is the potential for vintage returns to be generated once market dislocation settles down. For example, research[4] indicates that in aftermath of a downturn, private equity investments consistently outperform long-term average returns.
Seeking out opportunity in the funds space
Within the private equity funds arena, several areas of opportunity stand out – and not just the obvious examples of distressed and special situations funds, where recessionary pressures and companies’ growing debt burdens will clearly have an impact on dealflow. Lower valuations will trigger increased buyout, carve-out and M&A activity, creating a rich seam of potential investment targets. Even venture capital strategies are starting to come onto private investors’ radars, now that valuations have been reset.
Net asset value (NAV) financing strategies could see a boost as exit options remain limited, triggering a greater demand for liquidity solutions, where private capital could step in. And interest in secondaries strategies is likely to be piqued as more high-quality portfolios are offered for sale on the secondary markets as investors seek liquidity.
As ever, assets that are either undervalued or investments in markets with high demand and sustained growth potential will always be popular. One example of the former in the current climate is value-adding, growth-driven real estate strategies which focus on identifying overlooked or unloved property assets which can be upgraded or redeveloped. Infrastructure and clean energies strategies are a good example of the latter, as governments seek solutions that can deliver the holy grail of secure, affordable and sustainable energy. Private credit strategies are also very much in play, as traditional sources of capital are in short supply, creating space for credit funds that can allocate to a wide range of debt solutions to fill the gap.
The expanding scope of co-investments
Another trend we are seeing and which will no doubt be of interest to private investors is the increasing volume of high-quality co-investment opportunities, where an investor invests alongside a private equity manager in a specific portfolio asset, rather than participating via a fund (which may also invest in the asset). Private investors are certainly paying attention to this growing part of the market and will want to find access to these, often unique, transactions.
As many institutional investors seek shelter from the storm with the big-name fund brands, and as debt providers have temporarily withdrawn from the lending market, highly-regarded mid-market fund managers are facing a funding gap. They are now seeing co-investing as a means to raise capital for specific transactions, either in primary or secondary investment rounds. Some managers have off-balance sheet deals they need to sell-down, others are deciding not to raise blind pool funds at all, and instead do all their fundraising on a deal-by-deal basis. Private investors who can access this marketplace can participate in sizeable deals alongside top-tier fund managers.
Beating the 2023 hangover
Private investors’ push into alternatives has been gaining ground for some time but it is being given extra impetus by the turbulence of 2022 and its hangover this year. The rationale for constructing a well-diversified investment portfolio has never been clearer. Including alternatives should help investors to capture the upside of major market trends while smoothing out overall portfolio volatility, improving performance over the long term. With so many different options falling with the alternative investments bracket, it should be possible to generate returns whatever the market cycle.
[1] Source: Refinitiv Datastream, chart by BlackRock Investment Institute as at 3 Jan 2022. Based on MSCI AC World and Bloomberg Barclays Global Aggregate
[2] Source: Preqin, Future of Alternatives 2025 Report
[3] Source: JP Morgan
[4] Source: Bain Capital, www.baincapitalprivateequity.com