Over recent years, demand and interest for private market assets has grown significantly as investors seek to achieve improved outcomes while enhancing portfolios with diversification benefits. Recent macro events have not stifled this renewed interest, with Covid, the global economic recovery and the Russia-Ukraine conflict all driving investors to seek opportunities to diversify and boost their future portfolio valuations.

 

In 2022, private markets AUM hit an all-time high of $6.3 trillion (£4.95 trillion), spurred primarily by asset appreciation within portfolios, according to McKinsey.

 

But these ongoing global issues raise questions for investors, their strategies and desired outcomes, and I believe that private markets may offer some answers. It was a pleasure, therefore, to address attendees at Mercer’s Global Investment Forum (the Forum) on this very topic, and explain how we believe private markets can play a valuable role within a portfolio while taking into account the unpredictability of the wider economic landscape.

 

The right asset in the right sector

 

As I highlighted to this Forum’s attendees, for investors to best understand inflationary developments within the private markets space, they need to ask two questions: Does the demand for private market companies change as prices increase? How will the valuation of those companies be impacted by rising interest rates? There is no short answer, but rather a simple asset-linked framework that can help.

 

Within the infrastructure equity space, the abundance of inflation-linked, long-term contracts or counterparties with high credit ratings acts as a layer of security, yet there is more to it than that. A common characteristic across many infrastructure investments is their role in everyday life, providing us with essential services. As a result, demand does not change as inflation causes prices to rise, providing a good inflation hedge.

 

The real estate sector shares many similar characteristics, with inflation-linked contracts providing a cause for outperformance amid a high-inflationary environment. While retail properties are still reeling from the impact of the pandemic, a selective approach to choosing the right kind of asset can lead investors to areas where demand is increasing. Logistics, warehouses and data storage, for example, are segments of the market in high demand, making it much easier to pass on increasing costs.

 

Within private equity, the focus is on the fund manager, but there are some questions investors can ask that will help them to paint a picture of how well these businesses can mitigate inflationary risks. Is the manager running a ‘people-like business’, so that when wages increase, the profitability of the companies they manage isn’t as impacted? Can they pass on higher energy costs to the end consumer? Can they control the level of debt within the capital structure in anticipation of rising interest rates?

 

In an earlier Forum session, I was interested to hear that attendees viewed private debt as an area that offers among the poorest protection against inflation. Neverthless, I believe there is a case to be made for the approach. Fundamentally, private debt loans are floating rates, so in a typical scenario, when inflation increases, so too does the interest rate. Therefore, if interest rates are increasing, the income private debt managers receive from the companies they lend to will increase. As Forum attendees could tell you, interest rates rising too quickly impede companies’ ability to repay their loans, yet the structural protections put in place by managers allow them to take control quickly, should they need to.


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Position for transition

 

Five years ago, the number of strategies for sustainably minded private market investors was limited, and results were mixed. But the range of strategies available to investors has massively increased, to the point that investors can identify the range of environmental and social themes they want in their portfolio. The UN Sustainable Development Goals is a prime example, allowing investors to choose managers based on the specific themes they want to target.

 

Compounding the rise in the number of strategies is the volume of data managers are reporting on. This affords investors the ability to see the real-world outcomes they are helping to create. What I find captivating about private markets investing is the flexibility it offers, allowing investors to approach an investment theme or asset, and on outcomes that other forms of investing are too linear to consider.

 

This is an area set to develop rapidly over the coming years on several fronts. With this Forum’s attendees, I shared the example of an infrastructure investor looking to pursue a strategy beyond a wind or solar farm, and intending to deliver social impact in Africa, alongside their other expected outcomes.

 

Already, I have seen infrastructure managers work with governments in Sub-Saharan Africa to build and maintain boreholes for the provision of clean water to the local population, and the use of solar-powered cookers to reduce the need for fossil fuels. Elsewhere, biogas plant digesters have been introduced into rural farmlands where workers can take the farm waste, put it into the gas digester and burn it cleanly and efficiently – all while producing the fertiliser for farmers touse on their land. Hitting Sustainable Development Goals has been an emerging trend within the private markets space, and I’m fascinated to see this continue over the coming years.

 

Other key themes highlighted at the Forum

 

Perhaps other speakers at the Forum were envious of the 20 minutes I had to dedicate to private markets, as the topic was raised numerous times across the event. This reveals how interlinked private markets investing is now with all corners of the investment universe, and how prominent the space is becoming.

 

My colleague Hill Gaston from Sustainable Investment Research articulated the invaluable role private markets are set to play within the impact investment space, highlighting that through private markets, an investor can be more specific about the exact type of impact they wish to generate. For example, focusing on the needs of a specific community through affordable housing projects.

 

Michael Lernihan, Wealth Leader, Europe, Mercer, touched on the “innovation and collaboration” evident within the entire private market space, from investors with bold and novel ambitions to the small start-ups pioneering new solutions, as well as the interest the space is gathering from a broadening range of clients.

 

Finally, Niall O’Sullivan, CIO, Europe and EMEA, summed up our views on private markets far more succinctly in two sentences than I did in 20 minutes – if an investor was faced with the question of where to turn to for diversification benefits, taking into account the economic landscape and the shift to sustainable investing, then the case for private markets is strong, especially given its track record of generating additional returns.

 

Above all else, I hope this Forum’s attendees leave the event with the sense of that the possibilities for private markets investing are bountiful. Even if your primary reason to invest is for diversification, I believe you may be surprised at what else private market investments can do for your portfolio.

 

This presentation is for sophisticated investors only who are accredited investors or qualified purchasers. Funds of private capital funds are speculative and involve a high degree of risk. Private capital fund managers have total authority over the private capital funds. The use of a single advisor applying similar strategies could mean lack of diversification and, consequentially, higher risk. Funds of private capital funds are not liquid and require investors to commit to funding capital calls over a period of several years; any default on a capital call may result in substantial penalties and/or legal action. An investor could lose all or a substantial amount of his or her investment. There are restrictions on transferring interests in private capital funds. Funds of private capital funds’ fees and expenses may offset private capital funds’ profits. Funds of private capital funds are not required to provide periodic pricing or valuation information to investors. Funds of private capital funds may involve complex tax structures and delays in distributing important tax information. Funds of private capital funds are not subject to the same regulatory requirements as mutual funds. Fund offering may only be made through a Private Placement Memorandum (PPM).

 


Michael Butler
Michael Butler
Alternatives Investments Director, Europe – Mercer Investment Solutions

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