John Ivanac
The surprising slow-motion liquidity crunch that impacted private markets globally in 2023 proved to be a jarring alarm bell announcing that the easy money environment investors had enjoyed for more than a decade is finally over.
While the public markets appear to have priced in several Fed rate cuts during 2024, it will take quite some time for the system to work through what is effectively a liquidity queue as investors wrangle with very different assumptions than they used in their original underwriting theses.
As a result, those who have the flexibility to provide liquidity or deploy additional capital should be able to take advantage of compelling risk-return opportunities in 2024. While some asset classes like private equity and venture capital may still be on a path to recovery, others are already positioned to thrive. Today we see compelling opportunities in certain pockets of the private markets, but investors need to tread carefully and act with more precision than had been the case during the “zero gravity” cycle we’ve just exited.
The Liquidity Queue
As we think back to the world that emerged from Covid-related lockdowns in 2022, investors faced the types of headwinds they’d not encountered since the 2008 global financial crisis, including:
- Rising inflation,
- Gyrating markets,
- Spiking cross-asset correlations, and
- Heightened geopolitical turmoil.
As a result of the market downturn, equity and fixed income allocations shrank in lockstep, leaving portfolios over-allocated to private investments. At the same time, lofty private equity valuations led many institutions to question whether the prices they paid for the 2019–2021 vintages might be overvalued.
Then the first half of 2023 brought the largest banking collapses since the global financial crisis, contributing to the uncertain macro environment.
Today, as the U.S. moves from an economic environment with rising inflation to one with weakening economic growth and falling inflation, monetary policy and credit conditions have become more restrictive as interest rates have risen. That precipitated a domino effect on liquidity.
Although the investment environment appears inhospitable, and many investors are rethinking their 2024 allocations, this may be a period when taking additional risk is warranted. A PitchBook analysis of fund returns across private market strategies by vintage year from 2006-2018 shows that some of the highest returns were achieved in the period of 2008-2010 following the global financial crisis, possibly the most difficult macroeconomic environment in a generation.
Periods following crises are very challenging for investors who fear the “catch a falling knife” scenario. But they need to remind themselves of their investment horizon. For institutions with the patience to play the long game, we believe opportunities in certain areas such as secondaries and real estate debt, as well as parts of the private credit market, are worth considering.
Secondary Investments
From 2011-2021, private equity generated 11 consecutive years of net distributions to limited partners, which effectively made these illiquid investments “self-funding.” according to PitchBook However, private equity exits slowed dramatically in 2022, and have all but come to a halt in 2024, it says.
As a result, institutions have become over-allocated to private market investments, which means they may need to make some active portfolio management decisions.
For managers who can provide creative liquidity solutions, this is proving to be a buying opportunity for high-quality assets that are for sale at attractive valuations.
The secondaries market has grown substantially over the last decade, from $20 billion in 2006 to $134 billion in 2021, PitchBook reports. Yet annual secondary volume hovers around $100 billion, while private market investments represent over $10 trillion in assets, which suggests there’s a very good runway for growth. For private equity investors, secondaries may be the most compelling risk/return opportunity over the next several years.
Private Credit
At the end of 2023, the private credit market had grown to more than $1.5 trillion. Preqin, which tracks alternative markets, expects private credit to grow 11% per year, reaching $2.8 trillion by 2028.
Private credit investors overall have new negotiating power due to significant retrenchment by traditional financing sources. Middle market corporate borrowers may finally be forced to reckon with the long-term debt issues they’ve been able to overlook for the past decade with repeated amend-and-extend operations.
This is also resulting in a resurgence in more niche areas of the market, including U.S. and European special situations and commercial real estate lending, where we are seeing a significant – and rapidly approaching – maturity wall.
Real Estate
Like most asset classes, real estate represents a large and diverse set of opportunities. Experienced managers and allocators who have invested across cycles and who have the capability to pivot adeptly across the real estate landscape will likely be rewarded for their ability to be opportunistic in today’s challenging market environment. While the office apocalypse has dominated news coverage, the industrial and multifamily sectors continue to represent attractive long-term opportunities, along with specialty property types such as life sciences and self-storage.
With $2 trillion of low-interest real estate loans set to mature over the next four years, according to Trepp, a provider of commercial real estate data, the market is currently re-pricing assets due to rising interest rates rather than declining cash flow, with the exception of some AAA office buildings. This means investors may be able to access marquee assets at attractive valuations.
John Ivanac is a senior vice president of private investments at Franklin Templeton Institutional.
This feature is to provide general information only, does not constitute legal or tax advice, and cannot be used or substituted for legal or tax advice. Any opinions of the author do not necessarily reflect the stance of ISS Stoxx or its affiliates.
Tags: Alternatives, Liquidity, Private Credit, Real Estate, secondary sales