Next year, private market investors should focus on mid-market companies with low debt and potential for operational improvement, says Dirkjan Schuiten, head of private markets at ABN Amro. This approach contrasts with the less reliable strategies of financial engineering and betting on rising valuations, which are unlikely to yield desired returns in the near future.
Despite the looming challenges in private markets, experts remain optimistic. While recent quarters have seen a decline in new money raised, particularly in comparison to the peak in 2021, and higher interest rates posing challenges for private equity and private credit investors, specialists believe these aren’t reasons to overlook this asset class. Schuiten emphasises the long-term nature of these investments, asserting that the timing of entry is not the most critical factor.
Investment decisions in private markets revolve around additional return prospects, risk profiles, and managing illiquidity. Building a diverse portfolio within these markets is key to spreading risks.
«The current interest rate environment makes debt financing costlier, steering investors away from highly leveraged companies,» notes Koen Ronda, head of private markets investments at IBS Capital Allies. The middle segment, particularly in healthcare and technology, is deemed attractive due to lower debt levels, growth prospects, and margin improvement opportunities. Goldman Sachs Asset Management (GSAM) echoes this sentiment, focusing on operational growth in companies.
Three pillars of private equity returns
Schuiten: «Private equity traditionally has three sources of return. If interest rates are low, you can go a long way with financial engeneering, restructuring the balance sheet. If the macroeconomic outlook is good, you can expect the valuation of companies to go up, then you do multiple arbitrage. Finally, you can make returns at any time by improving a company operationally. We are currently pricing very tightly on the latter, which we believe is now the main source of future returns.»
Max Ramirez, head of Alternatives Client Coverage for EMEA at GSAM, again points to the high interest rate environment, which is currently (and likely to remain next year) making the market for leveraged buyouts less attractive. «We therefore focus on the companies where real operational growth is possible,» Ramirez says.
Impact investments
GSAM manages 456 billion dollars in private markets investments globally. This includes private equity, private debt, infrastructure and real estate, with most of the capital invested in private credit and private equity. In recent years, infrastructure has been particularly popular with investors because it is often an impact investment.
«The energy transition and renewable energy are particularly popular with European clients, both in equity and credit,» Ramirez says. And this is not just about the ‹safe› core and core-plus strategies. ‹Value add is currently a much sought-after option, especially now that some parts of the energy transition require new infrastructure developments - for example, battery storage or methods of power generation such as biomethane.›
Aren’t high interest rates throwing a spanner in the works here? «Increased interest rates do make financing offshore wind farms, for example, more difficult now,» says Ronda of IBS. «Offshore wind has and different earnings profile than, say, onshore wind, it is more expensive to build a wind turbine at sea than on land.»
On the other hand, infra is an excellent inflation hedge: «Many times there is constant, indexed income against the financing.»
But even in infrastructure, IBS prefers to choose the slightly smaller-scale growth projects. Ronda: «Picking the branches where the growth is, the debt is low and where hands-on work can add a lot of value. That is what we now see as the task for private market investments. Back to basics.»
This private markets outlook is the final article in a series of four 2024 outlooks published by Investment Officer. On Wednesday 13 December, the CIOs of Europe’s three largest asset managers gave their views. On Tuesday, we outlined the outlook for equities, on Thursday that for fixed income markets.