Record levels of funds invested into private asset strategies has led to the phenomenon of “too much dry powder” in which new investments fuel higher entry valuations for the slower-growing number of underlying investment opportunities. Nils Rode, Schroders Capital’s Chief Investment Officer, explained that avoiding this involves locating successful investments, those that benefit from a “complexity premium”, as private assets move into a new phase.
“There have been very strong tailwinds for private assets, the strongest we have ever seen in this industry over the last few years,” said Rode. He said that these winds have been strongest in areas like technology, health care, climate change and renewables, but the scale has led to challenges, especially for new investments.
The phenomenon of too much money chasing too few investment opportunities led to the title of the Schroder’s Capital event at which Rode and his colleagues spoke: “Too much dry powder? Where next for private assets?” The solution as Rode sees it is to be “especially selective.”
A new premium
How does an investor select the right private assets investments? Rode explained Schroder’s concept of the “complexity premium” for private assets that outperform. Private assets investors once got a premium for accepting illiquid investments. However, now that many investors are actively seeking illiquidity, that incentive has faded away.
Rode explained that the high and above-average returns of complexity premium can be found where there’s a complex investment opportunity or one involving skills that few investors have. He explained that this premium applies to the whole investment process.
Allows diversification
Rode said this premium can be found along “the long tail of private assets,” allowing for diversification. “That’s the vast majority of the private asset markets, which consists of the smaller and midsize transactions.”
Complexity and the importance of diversification “are not only driven by the current market environment,” Rode explained. “but they’re also part of some longer term trends that we observe in the private assets industry.”
Fourth phase
Schroders said that private assets have entered “a fourth phase of private assets”. They call it “private assets 4.0”, an area “where there are significant changes that will only accelerate over the coming years” in the areas of return risk, sustainability, impact and liquidity.
Tim Creed, Schroders head of private equity investments, discussed the role of active ownership and focus on strongly performing sectors such as healthcare and technology, combined with a long-term investing approach as reasons why private equity is doing so well.
Democratisation
Creed discussed how new structures are providing retail investors and defined contribution investors with democratised access to private assets. He mentioned open-ended vehicles with monthly subscriptions and quarterly redemptions, most common of which are regulated in Luxembourg. He also mentioned investment trusts.
Chantale Pelletier, Schroder’s global head of infrastructure, said that there’s urgent need to build a cleaner and a more energy efficient system as part of the energy transition. Global investment in that transition reached 500 billion USD in 2020. At the same time, investment in digital infrastructure is necessary to bring about and democratise the digital revolution.
Investment framework
Maria Teresa Zappia, Blue Orchard’s chief impact and blended finance officer explained how Schroders has built an investment framework with sustainability and impact embedded into the investment process. She mentioned the firm has a real estate impact strategy focusing on deprived areas in the UK. This is part of adding social impact and the concepts of inclusion and diversity within the overall investment process, she said.
Sophie van Oosterom, Schroder’s global head of real estate, presented on bifurcation of the real estate market. The firm sees value and income in the real estate sectors of retail, office, logistics and residential hotels, she said, but they move in different directions.
Haves vs have-nots
This is due to changes in the way consumers engage with real estate and how Covid has accelerated them. She also explained that “there is a very clear distinction happening between the haves and the have-nots.”.
There is great interest among investors and tenants for prime sustainable office buildings with high levels of amenity and enable employees to connect within the office space, she said. Offices lacking this “quickly becoming obsolete.”