Private capital has greater influence on markets and the global economy than ever before. Global pools of private capital, including private credit and real assets, have surged to more than $12 trillion, double the size from six years ago. Underpinning this growth, institutional investors have increased their exposure to private markets in search of yield and to reduce volatility in their portfolios.
The evolution of private markets has presented investors with a new set of opportunities as well as risks. In this webinar, PGIM experts examine the outlook for private market investing and consider some of the challenges that may come into play during a period of higher interest rates and inflation. The following are highlights from the discussion:
- The evolution of private markets: As PGIM’s newest Megatrends research explains, there are several forces that have fueled the expansion of private market investing. For example, banks have adjusted to new regulation and stepped back from riskier segments of lending. Meanwhile, during a lengthy period of low inflation and low rates following the GFC, investors’ search for yield and less-volatile valuations led them to increase private asset allocations. And given private markets’ growing influence, companies can now stay private longer because they can still access liquidity at scales they couldn’t before without going public. Much like the GFC gave birth to private market investing at its current scale, the current economic cycle could prove to be the catalyst that expands market share for this asset class – particularly for regions that remain heavily bank-financed, such as Europe.
- The lending outlook: The rapid rise in interest rates will affect valuations, and over the next 12 months, there will be pressure on property values. However, these kinds of environments often create opportunities in real estate debt. Borrowers are facing a lack of financing and liquidity in the market, and there will likely be opportunities in gap financing and mezzanine financing at risk-adjusted returns that investors have not seen for some time. Private market loans will be equally impacted, but lenders have the ability to actively manage borrowers and provide guidance. For instance, in the event of a downturn that leads to weaker performance, lenders can reduce a company’s ability to spend on growth initiatives.
- The impact of higher rates: Few companies have operated in an environment that combined recessionary pressures with a rapid increase in rates. Times like these will test a management team’s ability to operate through a difficult cycle. The current rate environment and the outlook for rising costs will also act as a constraint on M&A activity in private markets. As a result, direct lenders can be more agnostic about the channels they finance and consider non-sponsored, family-owned companies that previously would have gone to banks for strategic capital, for example. Some companies may view a potential downshift in the economy as an opportunity to grow, expand their market share, or consolidate within their respective industries, thus creating an opportunity for direct lenders to act as a source of capital even if macro trends weaken. With a backdrop of economic uncertainty and rising rates, the deployment of cash-like instruments will likely increase. Private markets will likely see a shift toward lending fundamentals, with less emphasis on valuations and greater focus on companies’ earnings and their ability to cover loans with free cash flow.
- The trends supporting real estate: REITs, which often serve as a directional gauge for the wider real estate market, indicate that there will likely be a broad-based decline. Some property types, such as offices, may experience more pressure than others. Given the rise in interest rates and the ensuing slowdown in property transactions, it will likely take at least another quarter before the outlook for valuations begins to come into focus. Still, demographic trends will provide support for private real estate beyond the current cycle. Despite cyclical headwinds from higher interest rates, demand for senior care housing and more affordable housing around the world will remain. Decarbonization and efforts to transition assets to a low-carbon footprint will also require capital. These trends should create new opportunities for investors.
This material represents the views, opinions and recommendations of the author(s) regarding the economic conditions, asset classes, or financial instruments referenced herein as of the date of issuance and is subject to change without notice.