Dispatch №14

Over the past decade, institutional investors have increasingly allocated their capital to private markets, more than any other asset class. This has led to a significant growth in assets under management for private capital fund managers, reaching over $10 trillion, an increase of 200% from 2011 to 2021. However, with economic challenges arising, the future of the private capital market is uncertain. The private market is currently facing increased scrutiny, due to factors such as potential new regulations, high valuations, market conditions, and macroeconomic challenges. The future of the private capital industry will be shaped by investor demand and the performance of current funds. A significant amount of attention is currently directed towards the private asset management industry, which has the potential to be worth trillions of dollars.

Private Capital and growth in AUM

Globally, institutional investors have put more of their incremental capital to work in private markets over the last decade than any other asset class. Coupled with increasing allocation targets and strong performance, private capital fund managers have accumulated well over $10 trillion in assets under management (AUM), a growth of more than 200% from 2011 to 2021. However, with macroeconomic headwinds surfacing, the question is, what does the future hold for private capital?

Private markets have never been under as much scrutiny as they are now. Between the potential for new regulatory red tape, questionably high valuation marks, the denominator effect, and macroeconomic headwinds, the next chapter for private capital will shape its future. A multi-trilliondollar spotlight is on the private asset management business, and the growth of the industry will depend on continued investor appetite in addition to the performance of funds active today.

PitchBook’s analysts project private capital global AUM to grow sizably but at a more muted pace compared with the prior five years. Analytical models suggest a cumulative growth of 20.7% to $13.0 trillion in total AUM by 2027.

However, the estimate varies widely. The potential for an economic downturn and a new inflationary regime could have long-term implications for private markets. Asset growth from fund performance and future fundraising are the two most important variables in our estimates, and they are also the most sensitive to the macro climate. To capture the uncertainty of future economic conditions, we have created three scenarios: a good case featuring a return to economic expansion, a base case involving a moderate downturn followed by recovery, and a bad case leading to more pronounced NAV markdowns across private fund holdings.

Different asset classes within the private capital umbrella will also be impacted in different ways.

Private equity

In many ways, the era following the global financial crisis (GFC) can be seen as the golden age for PE fund managers. Steady economic growth and persistently low benchmark interest rates acted as rising tides for flagship buyout funds across most geographies. Low interest rates juiced up returns by lowering financing costs and increasing discounted valuations, especially for the increasingly hot technology sector. As a result of strong performance and increasing LP allocations, the asset class reached a total AUM of $4.6 trillion by the end of 2021. However, Pitch Book expects growth in PE assets to slow over the next five years. With the exit window narrowing from macro headwinds, Pitch Book models weaker distributions to LPs, which will reduce the amount of money recycled into future commitments. Fund NAVs will need to be reevaluated as well, even in the rosiest of scenarios. Pitch Book forecasts indicate a base case of $5.3 trillion in AUM by 2027, representing a cumulative growth of 15.8% from 2021. This is a marked slowdown from the last decade, when AUM more than doubled.

Venture capital

No other asset class saw the benefits of cheap capital and sectoral tailwinds over the last decade quite like VC. The maturation of the industry since the GFC saw AUM reach $2.6 trillion by the end of 2021. As a result of fundraising records and valuation markups, the $2.0 trillion currently invested in fund NAV is at risk of further cuts as 2022 figures continue to come in. An expected slowdown in consumer spending and overall business activity will squeeze top-line numbers for startups, increasing the need for cost-cutting to extend runways to profitability or exit. Additionally, the startups that are nearing the end of their available cash and are yet to have a clear path to profitability may find it difficult to raise any capital in the current environment. While Pitch Book expects the asset class to recover, a healthy reset will be painful for some VC fund managers caught up in the euphoria of 2021’s growth-at-all-costs mindset. Pitch Book forecasts AUM to decline through the end of 2023 before rebounding to $3.1 trillion by 2027, representing a cumulative growth of 18.1%.

Private debt

Current investor appetite for private debt has been supported by the asset class’s solid performance amid global central bank rate hikes and attractive yields. Floating rate credit was one of the few bright spots for returns in 2022, in contrast with fixed-rate credit, which was battered by its duration exposure. Lending opportunities have surfaced as banks have pulled back from the leveraged loan market, and private credit has been swift to fill the gap. Fueled by growing interest from LPs, private debt fund AUM reached $1.3 trillion by the end of 2021, a sizable 202.7% growth over the past 10 years. Defaults and distress ratios have remained low through early 2023, indicating resilience for the asset class in the face of economic headwinds and likely encouraging new LP commitments as a result. However, with a looming economic recession, the increasing cost of debt, and the prevalence of covenant-lite terms over the past several years, the risk of missed payments is worth watching closely. Pitch Book forecasts that new inflows and relative insulation from an economic downturn will help AUM grow to $1.7 trillion by 2027, reflecting an annualized growth rate of 4.4%.

Real estate

Since the popping of the real estate bubble during the GFC, global fundraising for finite-life, closed-end funds has remained relatively muted. Fundraising for the asset class reached $152.3 billion in 2007, topping this number only in 2019 and hovering near it through 2020 and 2021.7 Cap rates at historically low levels will not be sustainable if risk-free government bonds trade near similar levels. The expectations for high rent growth in industrial and residential sectors that have justified low cap rates will likely need to be pulled back, resulting in a reset in valuations. Likewise, a retraction in the business cycle would lead to headcount reduction, further culling demand for commercial office space. Despite these risks, the present economic headwinds are not born out of the real estate sector. Therefore, markdowns are likely but are probably lighter compared with those during the GFC, and a rebound when the cycle turns is likely to buoy real estate investment demand should inflation persist above 2% targets. Within closed-end vehicles, global AUM for the asset class surpassed $1.1 trillion in 2021, with private NAVs showing little signs of devaluations like those seen in public REIT securities. Recently, cracks have begun to show, with private REIT redemption requests hitting mandated limits. While fund returns in 2022 so far have not moved south, Pitch Book expects the sell-off in public REITs and negative sentiment for the real estate sector to hit fund returns in 2023. As we look to this year and beyond, upcoming reappraisals of fund properties will likely hamper total assets in the short term before a return to growth brings AUM to $1.3 trillion in 2027 in Pitch Book base-case forecast.

Real assets

Real assets funds have seen healthy but shifting investor appetite recently, with oil & gas funds suffering a pullback by institutional investors conscious of environmental, social & governance criteria. Total global fundraising for real assets funds reached more than $136.2 billion in 2021, and the first two quarters of 2022 saw strong new commitments to these funds. While this trend slowed in the latter half of 2022, real assets fundraising for the year is on track to surpass the average over the past decade, driven by substantial commitments from national governments and institutions to infrastructure, an attractive subcategory of real assets funds that provide more durable yield-generating returns in times of inflationary pressure. This trend is likely to persist as Western governments refocus efforts on building resiliency with their energy sources and telecommunications projects have a long road ahead in the postdigital age. Global AUM for the asset class topped $1.1 trillion in 2021, on par with private debt and real estate AUM. Pitch Book expects real assets AUM to reach $1.5 trillion by 2027, representing a cumulative growth of 37.1% from 2021.

Attitudes survey by Knight Frank:
How are UHNWI creating wealth in 2023?

Global movement has been tempered by the pandemic, but the desire to be mobile is proving resilient. Some 13% of UHNWIs are planning to apply for a second passport or new citizenship, down from the 15% recorded in last year’s report.

Globally, a third of total wealth is allocated to UHNWI’s primary and secondary homes. More than a quarter is held outside their country of residence, on average. UHNWIs in the Middle East (41%) have the highest global footprint.

The average UHNWI owns 4.2 homes globally. UHNWIs in Asia have the greatest appetite, owning an average five homes each. This demonstrates the unwavering global appeal of residential property

Higher interest rates will temper demand for residential property in 2023. Some 15% of UHNWIs are looking to purchase a residential property this year, down from 21% in the previous year’s survey. Appetite is highest amongst Middle Eastern UHNWIs

The US, UK and Spain are the top three locations for purchasing homes. Australia and France round out the top five.

UHNWIs are increasingly diverse, both by geography and asset class. More than a fifth of our respondents’ investable wealth is directly invested in commercial property and a similar proportion is held overseas.

Real estate was identified as a top opportunity, both for direct and indirect investment. One in five UHNWIs are planning to invest directly in 2023, with 13% looking for indirect opportunities. This is broadly in line with the 20% of last year’s survey, indicating the attraction of property as a haven during economic uncertainty.

Healthcare, logistics/industrial and offices are the top target sectors for UHNWIs in 2023. The private rented sector (PRS) and hotels/leisure complete the top five. Around a third of respondents are interested in each of the top five sectors in 2023.

Energy source (57%), opportunity for refurbishments (33%) and materials used/the embodied carbon footprint (30%) are increasingly being looked at by UHNWIS when purchasing investment property.

Art is set to remain the most sought-after investment of passion in 2023 with 59% of UHNWIs likely to make a purchase. Watches come in second, with 46% looking to purchase, followed by wine with 39%. In terms of how much they will spend – art is again at the top, followed by classic cars and wine.

Links to consider

Books that caught our attention this week

Up Close and All In: Life Lessons from a Wall Street Warrior

by John Mack

In Up Close and All In, Mack traces his personal journey from a one-stoplight North Carolina mill town to a fortieth-floor corner office on Wall Street—and shares the life lessons he learned along the way. He developed a titanium-strength stomach for risk, stress, and competition while landing accounts early in his career, as investment banks fought like wolfpacks to take advantage of new deregulation, fielding business raids, booms, and busts. As he rose through the ranks, he never forgot where he came from, relying on his instincts, doing what was right, and listening to his people on the front lines. This culture of trust and collaboration helped Morgan Stanley anticipate future trends before other firms, adapt quickly, and achieve record profits. This gripping memoir includes both humbling lows—like when Mack made the difficult decision to leave Morgan Stanley in 2001—and exhilarating highs—such as when he made an eleventh-hour agreement with the Japanese bank Mitsubishi to save the company during the 2008 financial crisis, having refused to give in when top regulators pressured him to sell the firm for $2 per share.

Amazon

Investing Amid Low Expected Returns: Making the Most When Markets Offer the Least

by Antti Ilmanen

Investing Amid Low Expected Returns: Making the Most When Markets Offer the Least provides an evidence-based blueprint for successful investing when decades of market tailwinds are turning into headwinds. For a generation, falling yields and soaring asset prices have boosted realized returns. However, this past windfall leaves retirement savers and investors now facing the prospect of record-low future expected returns. Emphasizing this pressing challenge, the book highlights the role that timeless investment practices – discipline, humility, and patience – will play in enabling investment success. It then assesses current investor practices and the body of empirical evidence to illuminate the building blocks for improving long-run returns in today’s environment and beyond. It concludes by reviewing how to put them together through effective portfolio construction, risk management, and cost control practices.

Amazon

When the Heavens Went on Sale: The Misfits and Geniuses Racing to Put Space Within Reach

by Ashlee Vance

Through his trademark immersive reporting, Ashlee Vance follows four pioneering companies—Astra, Firefly, Planet Labs, and Rocket Lab—as they build new space systems and attempt to launch rockets and satellites into orbit by the thousands. While the public fixated on the space tourism being driven by the likes of Jeff Bezos and Richard Branson, these new companies arrived with a different set of goals: to make rocket and satellite launches fast and cheap, thereby opening Earth’s lower orbit for business—and setting it up as the next playing field for humankind’s technological evolution, where we can connect, analyze, and monitor everything on Earth. Vance has had a front-row seat and singular access to this peculiar and unprecedented moment in history. When the Heavens Went on Sale travels through private company headquarters, labs, and top-secret launch locations around the world, including California, Texas, Alaska, New Zealand, Ukraine, India, and French Guiana. He chronicles it all in full color: the private jets, communes, gun-toting bodyguards, drugs, espionage investigations, and multimillionaires guzzling booze to dull the pain as their fortunes disappear.

Amazon