Private markets are likely to contract more than in 2023

Everyone loves a dramatic blowout in the markets—a big moment we can all point to and say “Look! That thing was ridiculous!” And regulators can pat their chin and say lessons must be learned.

The best example in 2022 was, of course, cryptocurrency, as the collapse of the FTX exchange demonstrated the absurdity of an industry built on top of an asset class with zero intrinsic value.

The second prize (and it’s a close race) goes to the UK’s short-lived government debt crisis. Former Prime Minister Liz Truss’ brief rule showed the world what happens when you take bond investors for granted in a system of high inflation.

It makes sense now to look for the next blowout, and private markets are one area under the microscope.

Private debt and equity were the next big thing This time last year. At the time, bond yields were pegged to the ground — that was really a quiet place for asset allocators to try and make any money for stakeholders. Instead, many have ventured into the private markets in search of higher returns.

Often this means locking up money for several years, for example in private equity cars, real estate or infrastructure, in return for the prospect of an exorbitant payout. The best or worst thing about this, depending on your point of view, is that closed-end private investments do not cause price movements in real time. You don’t get constant movements on the screen to say your money is growing or, more likely over the past year, shrinking. Instead, you wait from quarter to quarter to see how the value of the investments has changed.

Some observers, such as Rochir Sharma, president of Rockefeller International, have called this a “hopeful conspiracy of silence”.

“A moment of reckoning will likely come when and if the downturn continues, and private markets must finally reveal losses in a bear market.” Wrote for the Financial Times in December. The next round of quarterly data is sure to result in a bleak read for large investors who have parked money in some private markets.

Common sense says this industry will have a tougher time in 2023, and not just because yields on safer things like government bonds have shot higher. Two other big things have changed: First, the public markets — stocks, bonds, and the like — have had a terrible year. And suddenly, it means that institutional investors’ relatively small and conservative allocations to private markets make up an uncomfortably large portion of their portfolios.

Secondly, the explosive gold market crisis in the fall showed in practice how important liquidity is. When you need money in a hurry to pay off a side call, it’s not helpful to waste a lot of hard-to-sell assets.

All of this could produce a kind of flash point in 2023. But the most likely outcome is a multi-year slow hole in the low drama.

True believers in markets such as private debt still have faith and with good reason. Randy Schwimmer, senior managing director at Churchill Asset Management in New York, fully acknowledges the challenges this sector faces. “But once the Fed begins to taper (and eventually conclude) raising interest rates, markets will return to more normality,” he said in a recent note, and the generous yields on public debt will vanish.

“Buying private credit now, or adding to an existing position, protects portfolios from future price shocks,” he said.

Unfortunately for those who thrive on drama, this fundamental support from major funds and specialists alike is one reason why the private markets frenzy is reasonably likely to subside rather than resurface.

Certainly, if large investors are concerned that too large a segment of their investment portfolios is locked into the private markets, they can sell. However, it is more likely that they will stop or slow any buildup, in part to avoid crystal losses from occurring.

“People have already committed” to asset classes like private equity, says Dan Morris, chief investment officer of Systematic Investments and Solutions at Allspring — an asset manager that was snapped out of Wells Fargo a little over a year ago. “I think they’ll stick with it. I don’t think there will be a lot of selling.” Instead, funds with large private market holdings will think more carefully about what to sell and when in the event of an urgent demand for cash.

Still, the next time the sharply-clad private equity salesperson calls out the idea of ​​a new allocation, the answer from many major funds won’t be thanks, he suspects, especially with US government bond yields more than twice as high as they have been this time of year. last year.

Another possible outcome is that investors are looking for a middle ground. Many asset allocators will likely stop snapping up more private assets, but still seek some type of exposure through listed dealers and infrastructure-related corporate bonds, says Altaf Kassam, European head of investment strategy and research at State Street Global Advisors.

It would look silly, and not for the first time, if private markets collapsed in 2023. But for now, even skeptics think that’s unlikely.

katie.martin@ft.com

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