US stocks have seen the worst start to a year since 1970. A bear market, and possible recession, loom. A number of major indices – from the Nasdaq-100 to China’s CSI 300 and Germany’s DAX – have been in bear territory already this year as worries over inflation, rising interest rates and global growth prospects bite.
But with more investors diversifying away from a traditional 60/40 portfolio mix, and behemoths such as the California Public Employees’ Retirement System (CalPERS) and British Columbia Investment Management Company upping their private markets allocations, the question of how the alternatives sector will fare as economic and market conditions deteriorate has become increasingly important.
Indications are promising to date. Global hedge funds have outperformed both the Nasdaq and S&P 500 through 2022 so far. Hedge fund managers were down -0.72% in April, compared to -12.54% for the Nasdaq and -8.08% for the S&P 500. Hedge funds have returned -1.83% year-to-date, while the S&P 500 slumped -13.31% over the same period. The combination of performance and net inflows have helped hedge fund industry assets under management climb to $3.624 trillion (or top $4 trillion, depending on your data provider of choice).
In private equity, the proportion of limited partners with net annual returns of 16% or more across the lifetime of their portfolios is nearing record levels, notes Coller Capital’s latest Global Private Equity Barometer. Over 70% of LPs say their private equity portfolios have outperformed their public equity holdings since the financial crisis.
Private equity’s illiquidity – one of the primary reservations investors ordinarily have with the asset class – could be helpful in the current environment. Since PE funds aren’t publicly traded, they don’t move in concert with public markets. As well as offering diversification benefits, the long-term investment commitment and infrequent pricing can dampen the volatility seen in public markets and act as a hedge.
Private equity managers can also operate without the constant pressure to deliver short-term gains that the senior leadership of publicly-traded institutions are under. PE firms have greater freedom to take strategic decisions that can boost their portfolio companies’ fundamental strengths and create long-term value. The significant capital reserves many private equity funds have available can be used to develop new offerings, tap into opportunities in new markets or make acquisitions.
The private capital sector as a whole though tends to perform better in low-rate environments, notes a recent Preqin blog. While private capital demand may not suffer, this year’s rise in interest rates will increase deal prices, which could revert performance back to the mean.
Private credit is one area that gets a mixed forecast in the Coller Capital Barometer. It found that more than half of investors see attractive opportunities in private credit funds targeting North America and Europe in the next two years. Yet one in three North American investors, and one in five European investors believe rising interest rates will lead to more defaults in their private credit portfolios.
For the time being, investors appear to be keeping faith with the alternatives world. Half of LPs surveyed in the Coller Capital Barometer plan to increase their target allocations to alternative assets over the next 12 months, with infrastructure, private equity and private credit most popular.
But now more than ever, funds will need to keep investors onside through rigorous performance and risk analysis, along with on-demand, digitally-delivered communications that enhance transparency into how their money is managed.
Investors increasingly expect to see customised reports offering granular breakdowns of activity, positions and valuations. And they want access to a multi-functional web portal where they can view reports and interactive dashboards that provide real-time analytics, tracking and reporting of KPIs, and two-way fund/investor communications.
In the scramble to attract and retain investor allocations, nothing less will do.
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