As we approach the conclusion of 2023, stocks have demonstrated resilience. Notably, the US S&P 500 index is on track for a 22% increase in 2023, which would be about double its historical average annual return.
Despite this recovery, investors are grappling with lingering uncertainties such as geopolitical tensions, the spectre of war and persistent inflation, albeit on a downward trajectory from previous highs. Elevated interest rates and lingering fears of an economic downturn further contribute to cautious sentiment among investors.
Given these challenges, investors remain wary of increasing exposure to risky assets, particularly equities, potentially leading to suboptimal returns for the year.
In search of consistent returns commensurate with risk, investors are turning their attention to alternative avenues, notably the private asset market.
According to survey data from BlackRock Institutional, which polled more than 200 institutional investors, more than half expressed a desire to augment their allocations to assets outside the traditional market, with a specific focus on private credit.
Remarkably, up to 70% of respondents intend to increase their exposure to private equity (PE), even in the face of high market interest rates.
GOOD TRACK RECORD
While historical performance in a low interest rate environment has been a catalyst for growth in the private asset market, survey results reveal a nuanced motivation. Investors are increasingly drawn to this market not solely for high returns, but also to generate a steady income stream from their investments.
The survey underscores a significant shift towards investing in private credit, particularly in the form of direct lending with floating interest rates. This approach allows for high-interest returns while mitigating price risk associated with interest rate fluctuations.
Notably, private credit funds have historically outperformed fixed-income funds that invest in markets susceptible to mark-to-market fluctuations during periods of increasing interest rates.
Historical analysis suggests that PE funds established and raised during periods of economic slowdown or crisis, such as 2007-08, tend to yield higher average returns than those established under normal conditions.
During crises, enterprise values of companies often plummet, enabling fund managers to strategically invest in deals at advantageous valuations. This presents an opportunity to invest in high-quality companies facing financial challenges, with the anticipation of reaping higher returns as the economic landscape normalises.
Furthermore, when deals involve lower values, the reliance on borrowing or leverage by PE funds diminishes, contributing to enhanced returns.
Moreover, the protracted investment horizon of PE, typically spanning 8-10 years with limited liquidity, shields investors from short-term market panics.
This extended period provides fund managers the flexibility to time exits or ownership transitions, whether through an initial public offering (IPO) or secondary market sale to other PE funds, especially during market upswings.
STRATEGIC IMPROVEMENTS
Additionally, the close involvement of PE with portfolio companies allows for strategic guidance and improvements, fostering a conducive environment for growth.
As the year draws to a close, investors are urged to reflect on and reassess their investment portfolios and strategies.
The incorporation of off-market assets has proven effective in diversifying portfolios, enhancing stability and securing consistent returns.
However, given the diverse nature of private assets, each catering to specific market conditions, it is crucial to recognise that returns and risks vary across different types.
For instance, PE spans various business stages, including the early, growth, mature and declining stages. Different PE funds focus on each stage, tailoring their strategies accordingly.
Those keen on exploring investment opportunities are encouraged to reach out, seek additional information, and collaborate with their investment advisors to identify suitable investments aligned with their financial objectives.
Kean Tan is the head of investment solutions with SCB-Julius Baer Securities Co Ltd.