What's in store for private assets?

Resilient growth and moderating inflation in the US reflect positive supply shocks that are almost exhausted. A slowdown followed by a mild recession in 2024 is the most likely scenario. European economies are already weak and we expect them to remain so until the middle of next year - although positive real income growth should limit the size of the downturn. Most central banks have finished hiking rates and should begin cutting in 2024, as inflation fades further. Chinese policy easing is now stabilising activity, but there are long-term headwinds. Emerging markets are benefiting from moderating inflation and they are entering a policy-easing cycle. As we analyse the private markets landscape, it is important to consider the latest trends in key sectors and to address the evolving macro backdrop. 

Private equity

In a high-interest-rate environment, persistent inflation continues to draw down deal appetite in both Europe and the Americas, particularly regarding exit strategies. Many General Partners continue to extend out their exit horizons, avoiding lower valuations in anticipation of better market conditions in the future.

The latest third-quarter valuation multiples suggested that valuations are correcting at a modest pace across North America and Europe. In terms of sectors, financials and consumers have suffered the worst peak-to-trough declines while energy valuations are still rising. Technology multiples held up well heading into 2023 but have been hit since. However, they are still at a premium relative to other sectors.

We continue to see mid-market companies in Europe and the Americas contributing to consumption growth in urban centres. Therefore, we will focus on opportunities to invest in recession-proof industries like healthcare and information technology that capture global long-term trends. It is crucial to focus on upper-quartile managers who have a proven track record of unlocking value in portfolio companies' balance sheets.

Private credit

Demand for private credit continues to remain robust as traditional lenders pull back. Given the elevated returns, expanded spreads, and protection from a low correlation to gross domestic product, the risk-return dynamics of private credit have become extremely appealing. Careful deal selection for assets with downside risk remains crucial.

Default rates remain low by historical standards, but they are anticipated to rise in private credit as many private credit managers have not been fully tested since the Global Financial Crisis (GFC). In addition, the market dynamics are fundamentally different from the previous cycle.

Dislocation in the market is creating good opportunities, and lenders are in a position to demand stronger covenants and to execute deals at attractive risk-adjusted returns. Selectivity remains key. And with signs of distress and increasing default rates, high-quality deals are vital.

Infrastructure

Global infrastructure markets grappled with several shock factors over the year. These stemmed from macro and micro drivers, with a slower fundraising environment, increased financing costs, geopolitical risks, and valuation pressures (to name a few).

Despite facing volatility, core private infrastructure assets showed resilience. They provided inflation protection, cost pass-through mechanisms, and robust cashflow generation. The energy transition sectors, for example, continued to grow and large deals still closed. The US Inflation Reduction Act (IRA) provides a strong tailwind for investing in infrastructure spending. For example, technologies such as hydrogen, carbon capture and transport are attractive structural opportunities. Europe is positioning itself to increase domestic commodity supply and energy autonomy by expanding investments in renewable energy. Globally, digital and telecom infrastructure continues to ride a long boom, bolstered by macro headwinds and rising opportunities in digitisation.

Real estate

The global real estate market is progressing steadily through this current downturn. Capital markets (yields) have been recalibrating in response to higher interest rates and higher debt costs, which have been much faster than the correction following the GFC. In most regions, values have fallen between 15% and 30% in just two-to-three quarters, but we believe this revaluation phase is close to the end.

Real estate yield spreads remain tight versus the risk-free benchmark, but spreads are improving slowly - although they have yet to offer enough illiquidity premia.

In Europe, logistics have repriced most aggressively but with more to go for secondary offices. In North America, we are observing cap-rate expansion starting to slow down across sectors. Office defaults are becoming more visible in the US and several high-profile valuations are bringing expectations down to more realistic levels. Meanwhile, across industrials and logistics, renewal activity has remained robust, hence values have held up with a strong macro backdrop.

In Asia-Pacific, yields in most markets have barely moved since end-2021. As such, we think there are likely more outward yield shifts that need to take place in the next year. While logistics properties in many markets will likely see higher yields, the negative impact on capital values is expected to be mitigated by further rental upside.

Natural resources

Activity across natural resources is heavily driven by the global energy market. Energy prices continue to be the driving force of investment across the asset class, which is set to continue. The recent conflict in the Middle East has caused further uncertainties, which had started to fall in June. As the renewable energy transition continues to play out, metal and mining strategies have also seen increasing demand, given some metals are also essential in generating renewable energy.

While growth in renewables fundraising continued, it is a multi-year push toward decarbonisation. Interestingly, investment flows in North America renewables seem to be catching up with Europe. This can be largely explained by the IRA. In Europe, government infrastructure spending is expected to increase to reflect its transition to a low-carbon economy.

Going into 2024, it's likely that the demand for energy will be sustained, but there is uncertainty about how long this could last. However, investment opportunities across natural resources will continue, with the emergence of low-cost renewable power and the growth of carbon markets. This includes the role of timber in the global transition to net zero and lower emissions. 

Author: Lulu Wang, Portfolio Strategist, Private Markets
Nicole Reid, Research Analyst, Private Market Solutions