The author is the Chief Investment Officer of the Swiss bank Lombard Odier
Major stock indices have lost between one-sixth and a quarter of their value this year, but investors still prefer public companies over privacy. Why actually?
In recent decades, the field of private equity has been an example of success. In 2021 alone, fundraising and company acquisitions reached a record $ 1.2 trillion. At the same time, investors plan to increase asset allocation over the next five years. It is easy to understand why: Private equity investments showed a good return, and at the end of 2021 the median annual returns of private equity funds raised between 2008 and 2018 were 19.5% (IRR, or the annual growth that the investment is expected to yield).
High inflation and rising rates – the end of the party?
True, high inflation and rising interest rates are likely to lower the valuations of existing private equity portfolios, and declines in markets could make it harder for companies to publicly register when funds want to exit their investments.
However, higher interest rates and inflation are not a disaster for private assets. The impact of market corrections on privately owned companies is less significant in most cases, and the slowdown can be spread over years. Thus, while the S&P 500 fell around 52% from a record low during the global financial crisis in 2007-2009, a private equity fund lost a little less than half that value.
Private is the new public
Meanwhile, investors who are not exposed to private assets risk missing out on growth. In the US, close to 60% of revenue is generated by privately owned companies. Further growth may be ahead of us: the number of companies registered in the US has fallen by more than a quarter in the last twenty years.
Early-stage privately owned companies are also the ones promoting innovative technologies and innovative ideas. Investors who are not exposed to private companies are giving up the new and most promising areas – which drive long-term growth, especially in the area of sustainability. Today, private equity firms fund technologies and sectors that have not yet been extensively adopted by listed companies.
Inflationary hedging and opportunity due to the declines in the markets
Some private assets – real estate, infrastructure and private debt – provide active hedging against inflation. Rents (especially for commercial buildings) rise as prices rise, and investments in infrastructure projects, including energy and water, transportation, logistics networks, telecoms, roads and hospitals, capabilities Also provide an index-linked return, and private debt is expected to be the fastest-growing segment of private assets in the coming years.
In addition, we are in the best period to invest – historical data indicate that private equity funds, which were launched during periods of market declines, or before, showed good results compared to funds from other years. Such logic suggests that now may be a good time for investors to increase private equity allocations, or start with private equity commitments.
Optimal long-term investment strategies
For investors considering adding an allotment of private assets to their overall portfolio, a multi-year strategy that spreads liabilities across a number of different categories of private funds is usually preferable – from private investment and debt to real estate and infrastructure.
A consistent spread of capital over time disperses risks and prevents the possibility of missing returns in a particularly strong year.
The benefits of investing in a variety of private assets are: improved returns compared to public markets, lower volatility (lower exposure to short-term market movements and greater diversity), access to privately owned companies that complement traditional share allotments.
Investments in private assets of course have risks: loss of liquidity (capital can be “locked up” for up to ten years) and risk of loss of capital. In addition, choosing the right fund managers is critical. The difference between good and bad performing private funds can reach up to 20 percentage points.
Despite this, private assets play an important role in a diversified investment portfolio – even after rapid growth in private assets, amounting to just over $ 10 trillion, they make up only about 10% of the investment assets in the world. The market may double in size by 2026, and as such, the charm of private assets may last throughout the Fed’s rate hike cycle.