This year’s outlook from Schroders has revealed the forces shaping private markets are largely related to changing trends in investor demand and behaviour, alongside a backdrop of the significant likelihood of a prolonged recession.
Schroders CIO Dr Nils Rode urged investors to assess the medium-to-long-term outlook of the sector before making any decisions.
“Private assets are long-term in nature,” he explained.
“Over this longer time frame, numerous durable, long-term trends mean we remain optimistic.”
While he admitted that 2023 will be a difficult year to navigate, Dr Rode offered three key themes investors can focus on to optimise long-term return potential.
Steady investment pace
While an ambitious task, the CIO advised investors to keep up a steady investment pace.
Schroders’ analysis revealed that recession years tend to have higher performing vintage years, with the average internal rate of return of private equity funds raised in a recession surpassing 14 per cent a year, based on data since 1980.
“This is higher than for funds raised in the years in the run-up to a recession, which at the time, probably felt like much happier times,” Dr Rode commented.
He added that deploying capital over several years can additionally allow funds raised in recession years to pick up assets at depressed values in the pursuit of a later exit when valuations rise again.
Asset class-specific strategy
While valuations of private assets experience less volatility than listed markets, they are not immune to increases in nominal and real interest rates, Dr Rode explained.
However, there are specialised strategies in each asset class that should be resilient to even a prolonged and deep recession.
“Most of these investments can be found along the “long tail” of private assets. This is the 95 per cent of transactions — smaller and mid-sized — that typically present 50 per cent of the investment volume in each asset class,” Dr Rode said.
Schroders offered some less correlated strategies that can be found in the long tail of each asset class. Well-positioned strategies in private equity, for instance, include small-mid healthcare buyouts and early-stage biotechnology.
Avoid major dry powder overhangs
“During the COVID-19-induced boom-bust cycle, fund-raising for private assets has boomed. However, the build-up of dry powder has been unequal,” the CIO said.
Schroders’ long-term study of the deviation of fund-raising from its long-term trend as an early indicator for vintage year performance revealed that there is a negative correlation between the two.
Vintage year performance was found to be negatively affected when fund-raising has been above trend, as dry powder can inflate entry valuations.
Ultimately, Dr Rode advised investors to be patient with countering dry powder overhangs, noting that it can take quarters or even years to bring them back to more normal levels.
