Opportunities of private markets in a high-rate environment - Creand
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Opportunities of private markets in a high-rate environment

Private markets are increasingly the subject of conversations with investors. The rising interest rates we are experiencing has triggered the need to find alternatives to traditional assets to obtain returns that enable investors to meet their financial objectives. In this article we will focus on what we consider to be the most efficient way to access private markets and, specifically, private equity, i.e., investment in private companies that are not listed on the stock exchange.

The last 15 years have been an unprecedented era in the financial markets. After the global financial crisis of 2008, the European Central Bank (ECB) began lowering the benchmark interest rate with the aim of mitigating the damage to the eurozone’s economy. This global financial crisis was followed by the eurozone crisis and, once the ECB had pushed interest rates even into negative territory, in 2015 it announced further expansionary monetary policy measures with the main objective of returning to the path of economic growth.

Throughout this period, investors did not need to pay as much attention to asset valuations because the system was awash with liquidity. So much so, that the money in circulation in the economy doubled in the period from 2015 to 2022.

All that time, savers were investing in traditional assets, such as fixed income and equities, swept along by the TINA (“there is no alternative) trend. However, in addition, the reality is that it was a generally profitable asset during this period, [KM1] among other reasons due to the liquidity that flooded the system.

Having overcome the COVID-19 crisis, along came the war in Ukraine and inflation began to pick up strongly. The ECB had no option but to start raising interest rates sharply, and asset valuations began to adjust.

And thus, sovereign bonds, which had been at near-zero yields for almost seven years have become an attractive asset for investors. A clear example is the 3-month Spanish treasury bill yield, which was above 3.5% according to data from the last auction in October.

The reality at this time remains complicated for investors in traditional assets. While bonds are once again offering attractive yields, inflation in many cases exceeds these yields and continues to erode investors’ savings in real terms. Moreover, the traditional 60/40 portfolio, made up of 60% US equities and 50% 10-year US treasury bonds, had a negative return of close to -18% in 2022.

Given the circumstances, we are once again seeing that TINA trend we were talking about, but with much tighter valuations in some assets. This means that, this time, the only alternative for investors is to look for other types of assets with which they can obtain returns that will allow them to outperform inflation and meet their objectives.

As we have said, one asset class that improves the risk-return trade-off in most investors’ portfolios over the long term is private markets. It is no coincidence that investor demand for these assets is growing year on year. Private equity assets under management in 2021 amounted to over five trillion US dollars, and according to the financial data provider Preqin this figure is set to double by 2026.

One of the most efficient ways to access private markets is investing through a fund of funds. This type of vehicle offers investors access to a portfolio of diverse funds, allowing for diversification and access to funds that are generally inaccessible to most investors.

Success in private equity strategies depends, to a large extent, on the ability to identify the best managers (even more so in periods of high interest rates), with the difficulty that these star managers are the most inaccessible to new investors. For this reason, having the professional management provided by funds of funds allows investors to share in the returns of the best funds in the market.

In addition, building and managing a private market investment programme that is well diversified by strategy, geography or vintage requires a great deal of experience, capital and dedication. Again, the fund of funds helps investors to invest in well-diversified programmes, with professional management and without the need to allocate so many resources.

However, to successfully approach private markets, investors must have quality advice to undertake an investment in this type of assets. While we believe that these strategies improve the risk-return trade-off in most portfolios, it should be taken into account that they involve a series of risks that may not be suitable for all types of investors.

In short, the environment is becoming increasingly complex and this means that investors need to look for asset classes and strategies that complement their more traditional asset portfolios, such as private equity and other strategies within private markets. With this in mind, quality advice and professional management will provide investors with the added value they need to meet their financial objectives.

Published at Bolsamanía 31.01.2024

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Sergio Muñoz
Alternative Investments Director at Creand Asset Management