Worn down by pricey equities and super-skinny bond yields, asset managers are increasingly looking beyond public markets in search of decent returns.
This has been building up for several years. Already, Schroders points out that private markets are worth something like $8tn.
But last year’s serious pick-up in inflation is prompting some asset managers to look at assets including private debt and equity, as well as infrastructure and real estate, for the first time, or to push further into the space.
“Private markets used to be the preserve of wealthy investors and sophisticated institutions. But why does it have to be for wealthy family offices? People are talking about democratising private markets,” said Philippe Lespinard, head of asset management in London at Union Bancaire Privée.
For Lespinard, the calculation is simple. Government bond markets are just a “horrible” place to be. The acceleration in consumer price inflation since the world emerged blinking from the first set of pandemic lockdowns means buyers are effectively guaranteed a loss on many of these investments.
But it is not only government bond yields that have suffered the steamroller treatment. The central bank stimulus that has squished them has also dragged down yields on corporate credit, and some authorities have also bought corporate debt by the truckload.
“It’s [most] noticeable in Europe because the European Central Bank has been buying investment-grade and industrial bonds. They have compressed the credit spreads for even good liquid names like Nestlé or Siemens, not that those companies have a bad credit situation,” Lespinard said.
“When you compare European high-yield debt — and at yields of 2 or 3 per cent I think we need a new name — but you can lend to private markets with senior financing to, say, real estate developers for two, three, four, five years for a housing project at 6, 7, 8 per cent,” he said. “They are good quality and you are earning two to three times what you would be earning in the high yield market.”
Equities are fine, of course, but they can be volatile and some valuations defy any traditional logic.
That all pushes investors beyond the well-trodden path of listed, straightforward markets and into more adventurous waters. Calpers, the biggest public pension plan in the US with $500bn of assets under management, has already taken the plunge, with its board agreeing in 2021 to bump up its allocation to private equity by 5 percentage points to 13 per cent, and to buy private debt, putting 5 per cent of its money to work there.
Meanwhile, allocations to public equities are to be cut from 50 to 42 per cent. Public markets are “a little overheated”, chief executive Marcie Frost told the Financial Times in December.
Naturally, plenty of things can go wrong. You would not be earning 8 per cent on that financing to a decent housing developer otherwise. The main concern is liquidity. In a crisis, these are not assets that you can sell in a hurry — hence why public markets carry a so-called liquidity premium.
Calpers thinks it can take this in its stride. “We have sufficient ability to pay benefits if there was a market crash or a pretty significant downturn in the markets,” Frost said. But as private markets gather new fans beyond specialised investors, it is clearly vital that everyone buying has thought about the trade-off.
“The problem with the democratisation of private assets is that a lot of people are buying them without really understanding what the liquidity premium means,” said César Pérez Ruiz, head of investments at Pictet Wealth Management. “Liquidity is a fantastic thing that you can’t have when you need it. You need to make sure clients are willing to lose it. It’s not a free lunch.”
Potentially, having a larger slice of global investments parked in private markets could even open up public markets to greater vulnerability. As we saw in the spring of 2020, investors do not necessarily sell the stuff they want to offload when the going gets tough. They sell what they are able to sell, where they can most easily find a buyer.
Public markets could feel the greater force of selling pressure in the next big shock, because a bigger slice of portfolios is tied up in clunky private assets. Maybe. But private markets are probably not big enough for that yet.
In addition, the poorer liquidity in private assets may be less of a problem than it seems. Super-cautious, supersensible pension funds, for instance, lock up funds for the long term by design. Why worry if they cannot get out of a decent private investment by lunch time? Why sacrifice returns on the altar of liquidity?
Word is clearly getting around. “It’s a question we get a lot — how can I access private markets?” said Sonja Laud, chief investment officer at Legal & General Investment Management.
The shift to a new greener global energy mix — a process heavy on infrastructure and with a price tag in the trillions — means opportunities are out there. For her, though, the problem is that these markets are just still too small. “The volumes are not there yet. It is still a limited pool,” she said.
Maybe not for long.
Private markets are a hot topic for 2022 - Financial Times
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