Article published in The Business Times on 24 August 2022

Amid rising policy rates and economic headwinds, there are many good reasons to continue or start investing in private assets

The situation may look like a paradox at first glance.

Since the beginning of 2022, investors have been facing the worst combined drawdown in the bonds and equities markets over the last 50 years at least, a stress widely triggered by the liquidity drain engineered by the US Federal Reserve and other central banks, and the fear of a self-indicted recession. Nevertheless, they continue to pour money into private equity (PE), an asset class exposed to both economic growth and illiquidity risk.

It would be excessive to claim that fundraising for PE, and more globally private assets, has remained immune from the turmoil occurring in public markets.

How do Lombard Odier support clients in uncertain times? Read to find out.

According to Preqin, PE's fundraising has experienced a significant slowdown in the first half of 2022, with slightly less than US$235 billion raised. This comes after a 2021 vintage that was the second-best on record in terms of new money, with US$669 billion raised over the full year.

However, most of this slowdown took place in Europe during the first quarter of the year, as uncertainty spiked with the Russian invasion of Ukraine.

By contrast, PE activity continued to accelerate in Asia, with the number of buyout deals reaching 214 in Q1 2022 alone, up 23 per cent from the same period last year.

More importantly, asset allocators globally maintained or even increased their commitments, based on a Preqin survey among 350 limited partners (LPs) where 96 per cent of respondents claimed they should maintain their allocation in PE in 2022.

Meanwhile, many individual investors have redeemed en masse first their sovereign and credit bonds holdings and, more recently, their public equities investments since the start of the year.

How can one explain this resilience, at least in relative terms?

Read more about maintaining portfolio resilience amidst volatility

Staying the course

There might be many different reasons, some probably more relevant than others, but most of them are connected with one of the key features of private assets' strategies – their long-term horizon requiring a permanent investment discipline on a universe of frequently under-scrutinised companies or projects.

These factors may act through different mechanisms for either individual or institutional investors, but overall, they contribute to the same positive outcome: maintaining a constant amount of money at work over time, smoothing the impact from business cycles and allowing the accumulation of substantial long-term returns.

For relatively new or inexperienced individual investors, sticking to previous commitments in private assets programmes or even deciding to initiate their first investment into this range of alternative investments during times of intense market stress might result from a mix of liquidity arbitrage and psychological factors.

Obviously, the liquidity constraints and costs associated with the premature unwinding of a PE programme does prompt investors to de-risk their global portfolios in priority by selling their listed holdings.

The fact that private assets do not report frequent valuations, blurring somewhat their underlying economic volatility, may help – at the margin – to reduce the emotional charge associated with public assets during economic downturns or episodes of financial turmoil.

How do investors stay agile in the face of inflation and low global growth? Read on.

More fundamentally, private assets investments have become, over time and especially since the global financial crisis of 2008, the access door to an expanding universe of under-scrutinised companies.

These companies now cover close to 60 per cent of US companies' total earnings and two-thirds of the country's private workforce, operating however in business models or industries somewhat less fancy than the ones of the large, public, market-moving corporates.

When the economic cycle is deteriorating rapidly, these public entities are usually subject to an overwhelming flow of bad news, to which private businesses tend to be relatively immune.

Again, this does not mean that unlisted companies are not vulnerable to the same adverse macro factors. But it may explain why this category of investments is less prone to the type of panic-selling frequently experienced during or after markets' sell-off.

Seasoned allocators, institutional investors and experienced LPs' persistent discipline in committing to private assets through the economic cycle likely results from a more fundamental rationale.

They know the relative stickiness of private equity commitments due to their illiquid nature will provide general partners (GPs) the funding they need to ride the cycle, to exit past investments in a way less subject to brutal dislocations, and – for the most experienced GPs – to restructure and make companies grow at a critical time.

More importantly, they have in mind the usual cycle through which GPs usually deploy most of the capital committed in a given year over the next 3 to 5 years.

Read about Lombard Odier's commitment to clients in Asia

Maximise potential benefit

While there is no discussion on how rising inflation and interest rates impact valuations of existing PE investments negatively, which most of the time are discounted from public equities' valuation metrics, the same downward pressure on listed markets therefore provides huge opportunities to purchase assets at much cheaper prices.

This explains why private assets' vintages incepted during times of economic downturns or recessions, such as 2001, 2002, or 2009, have frequently generated significantly higher net internal rate of returns than the ones from vintages initiated when strong growth episodes were maturing, such as 1997 or 2006.

To summarise, there are many good reasons to continue, or start investing, in private assets at a time of rising policy rates or even economic weaknesses such as the present.

But to reap the full benefits of these strategies, private investors need to comply with the same principles observed by early pioneers and sophisticated institutions.

Firstly, start building a portfolio of diversified strategies – across large and small and mid-cap buyouts, venture, growth, secondary funds, private debt, real estate, infrastructures and so on – with each their own cash-flow profile, risk-return characteristics and sensitivity to some key underlying macro factors.

Secondly, do not try to time the market, but rather, maintain a constant level of commitment that will help smoothen the impact from the business and interest rates cycle, while ensuring the realisation of a self-funded portfolio over time, alleviating the initial liquidity constraint.

Thirdly, invest only with experienced GPs, as the return distribution between PE funds is very wide.

This might prove especially difficult, as the number of PE funds in early 2022 has never been so large on record and as best GPs remain largely oversubscribed, closing their access to new investors with relatively small tickets.

This is where and how reliable providers with secure access to these highly-demanded funds, proven track record in building and managing single- or multi-strategies portfolios, and the capacity to design allocations of private assets fitting an individual's goals and liquidity constraints, would prove highly beneficial to investors willing to initiate or expand their exposure to this universe.