What is the definition of Private Assets?
Simply put, Private Assets strategies are funds that invest in unlisted assets to support their growth over a period of usually 4 to 6 years. The assets are then sold, with a view to making significant capital gains for the investors.
There are 4 strategies for Private Assets.
Firstly, Private Equity funds, which invest as a majority or minority shareholder in companies at different stages of growth, such as start-ups, SMEs, or late-stage large industrial groups.
Secondly, Real Estate funds, which invest in offices, hotels, logistics or residential buildings.
Thirdly, Infrastructure funds, which invest in infrastructure providing essential services to the community, such as transportation as well as social or environmental infrastructure.
Lastly, Private Debt funds, which invest in all the asset classes I have mentioned, in the form of debt financing rather than via equity.
What has been the trajectory of Private Assets in recent years?
Private Asset markets have performed strongly over the last 20+ years, helped by positive macroeconomic trends, such as
- A robust growth backdrop - 5% global nominal economic growth on average since 2010;
- A historically low short- and long-term interest rate environment
- A resulting desire for investors to “hunt for returns” in higher-risk, more illiquid asset classes such as private assets
The one factor that has been less favourable for financial markets since 2022 is clearly the interest rate environment. Due to the surge in global inflation, global 10-year bond yields rose significantly, representing a headwind for all leveraged asset classes.
But the good news today for financial markets is that inflation rates are now returning closer to central banks’ 2% targets, allowing long-term interest rates to fall.
Who invests in Private Assets?
Private Assets funds, such as venture capital and leveraged buyout funds or LBOs, started to emerge in the Sixties, mostly in the US and later in Europe.
Most investors in these funds were institutional, so pension funds, insurance companies, sovereign funds, or foundations at major American universities.
Today, individual investors account for only 16%* of the world’s Private Assets funds, although this proportion is growing steadily.
How and why should one add Private Assets to a portfolio?
Private Assets seek a higher financial return than traditional asset classes, with lower volatility. These strategies therefore improve the risk/return profile of a portfolio, if you agree to take a long-term view, because these asset classes are illiquid by nature.
The Private Asset universe is extremely large. It is estimated that only 13%** of companies with over 100 million dollars in revenue are listed in the US and only 4% in Europe. Investing in private assets funds is therefore the most effective way to finance the real economy and diversify beyond listed equities and bonds.
Provided they have the right risk profile, we recommend that investors gradually integrate Private Assets into their overall wealth, while keeping a diversification of fund managers, strategies, geographies and vintages. A target allocation of around 10% would give the benefits I have described. That said, some family offices may be invested up to 30%, or even more.
Historically, how have Private Assets fared versus investments in listed assets?
Over a 10-year horizon, the IRR or internal rate of return observed on Private Equity funds was 16% in Q3 2023, compared with 8% for the Morningstar Global Stock Exchange Index.
This outperformance can also be observed over other investment horizons and across all Private Asset strategies.
However, I would like to stress that this average performance may mask a dispersion between funds. We observe that the average range of performance, between first-quartile and bottom-quartile Private Equity funds, is fifteen point five percent.
So when you decide to allocate a share of your portfolio to Private Assets, it is essential to select top fund managers. Furthermore you should pay particular attention to performance drivers. In other words, operational value creation is more important than leverage or valuation, particularly in today’s context.
What was the impact of rising rates on Private Assets?
The sudden normalisation of interest rates led to a slowdown in the Private Assets activity between twenty twenty two and twenty twenty three. However, the impact was minimal on performance, which continues to be driven by the strong operational health of companies.
The governance of Private Equity firms as active shareholders in companies, their fast response to market conditions and their operational expertise in supporting company managers are particularly effective advantages in changing environments like today’s.
Indeed, prior to two thousand and eight, the industry performed successfully in high interest-rate environments. Almost two decades on, the real economy has substantial financing needs, especially around themes such as artificial intelligence and climate change.
We therefore believe that the best fund managers who focus on value creation are adept in seizing attractive opportunities in a dislocated market, and they will continue to outperform listed markets in the future.
*source: Bain (https://www.bain.com/insights/why-private-equity-is-targeting-individual-investors-global-private-equity-report-2023/)
**source: CapitalIQ
***Past performance is not a reliable indicator of future performance