Private capital seeks smarter fund strategies in uncertain times

News: Insight & Opinion | 7 October 2021

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In times of uncertainty, where does the smart money go? When it comes to private capital, high net worth investors (HNWIs) and family offices can be agile in response to changes in the economic environment, much more so than their institutional counterparts.

Pre-pandemic, a sizeable tranche of the private capital community went long into cash to lock in portfolio gains and hedge against fears of an overheating stock market. This trend continued after Covid-19 hit, with increasing cash reserves viewed as a sensible way to protect against turbulence in public markets and provide investors with the liquidity to snap up good investment opportunities, when they presented themselves. And many are now seeking to do just that. So, what types of strategies and fund managers are they on the lookout for?

Going for gains
While producing an income has been a high priority for many in the low yield environment of recent years, attention is now turning to assets with potential to generate capital gains while prices are attractive. Research among our HNWI and family office clients earlier this summer found that more than seven in ten respondents view achieving capital returns as an important characteristic when looking at potential new alternative asset investments. By contrast, just over two in ten said the same for investments that produce income.

Many investors are simply seeking good opportunities wherever they arise – whether that’s funds whose assets have been adversely affected by the pandemic, those that haven’t, or those whose portfolio businesses have been enhanced by it. According to our findings, portfolio diversification and generating outsize returns are front of mind.

In terms of sector and investment stage, technology is a key area of focus, and we’re currently seeing significant demand for venture capital (seed and series A) investments in areas like “deeptech” and business-critical software strategies, as well as more widely in consumer markets. The key here is having access to the best-performing managers: the private capital community want to know that the fund managers they back can spot the real rising stars.

Seizing opportunity
To do so, fund managers need to be specialists in their niche, and they need to have the flexibility to be able to deploy capital in an agile and efficient way to drive returns. Often this means funds that are smaller in size – which may put them beneath the notice of large institutional investors, leaving the way clear for private capital to act as a vital source of fund inflows. Private capital is also more willing and able to consider first-time fund managers (albeit, with excellent credentials in their chosen field prior to setting up their own fund), who once again, would be outside the standard investment criteria of the big institutions. In this way, strong and lasting relationships can be established between fund managers and private capital providers, creating mutual benefits over the long term.

In times of crisis, it’s natural that special situations and distressed credit funds should be an area of interest. However, the reality is that those looking to invest now may have missed the boat, as capital has been pouring into this sector for several years, as the market has long been expecting a correction in economic fortunes.

Targeting market dislocation and out-of-favour sectors
That said, there are plenty of openings for other types of strategies that target market dislocation. These include equity turnaround funds, traditional private equity secondaries strategies, or specialist secondaries funds that provide liquidity to private equity managers and investors without them having to dispose of fund assets. The impact of the pandemic has created a groundswell of demand for this kind of liquidity, as portfolio exits are delayed.

There are pockets of opportunity too in currently out-of-favour sectors such as commercial property funds. Savvy investors know that it could pay to go where others fear to tread, and that not all segments of the market should be treated the same. For example, development funds that focus on short-term holds by repositioning assets, expanding sites or pursuing changes of use, offer potential in the current climate. Or those that look at issues such as long-term demographic changes to focus on care home investments, or trends in consumer behaviour creating demand for logistics space.

There’s a palpable sense among the private capital community that, although the economy has experienced a sharp shock, they want to position themselves now to back the recovery. That means staying alert, thinking outside the box, and looking ahead to find the best strategies to diversify portfolios and to drive returns. That’s why specialist, niche funds are the order of the day.

A version of this article appeared in Investment Week.