he COVID-19 pandemic has continued to elevate levels of uncertainty in the economy and financial markets. Things like rising interest rates, inflation, labor force, supply chain disruptions, changing tax policies, soaring energy costs, political unrest and geopolitical uncertainty are some of the many macroeconomic concerns that those in private equity must deal with.
After 18 months of navigating the turbulence of the pandemic, private equity remains in a strong position. Ongoing research on the industry’s dynamics and performance has revealed key trends within the industry. Based on industry leading research and sources of data, this blog post will explain how to navigate and invest in private markets as we move further into 2022.
Private Market Investing Explained
Private equity is an alternative investment (i.e. private equity, private lending, venture capital and private real assets) or buyout made into companies that are not publicly traded. Investors in private markets aim to create value in private businesses by financing start-up companies, providing capital growth for fast-growing businesses, operational improvements, or other changes. However, the private market is not as accessible as the public market, because companies in the private market are not listed on a public exchange. There are many global investment opportunities that exist within private markets in a variety of different sectors.
Besides private equity, private markets include real estate, private debt, infrastructure, and natural resources. Investing in these markets can be done by investing directly or through a mix of private market funds. The following image illustrates the various categories of alternative assets:
What is private market investing?
Private market investing is long-term and complex; as a result, it requires a very strict due diligence process and structured approach. Those interested in exploring these markets should be aware of the financial and timing requirements:
- A limited time window, often two to six months, to decide whether to invest.
- Typically committing to a total amount instead of immediately investing a sum of money.
- Investing the total committed amount over a period of time.
- The exact timing of the contributions varies, as does the total investment period.
What are Advantages and Disadvantages to Private Market Investing?
Since private market returns are not highly correlated with public markets, private market investing presents both opportunities and risks that differ from public markets. The positive and negative attributes of investing in alternatives include:
- Return enhancement
- Inflation protection
- Diversification benefits
(Mercer Top Considerations for Private Markets in 2022)
private market funds are mostly illiquid
investors only realize potential returns when a fund sells a business or during an IPO
- BINDING COMMITMENTS
private market investors are legally obligated to provide money that is requested by the fund manager
funds usually charge a management fee and performance fee
(Diversification and Private Capital Investment: U.S. Bank 2020).
Top Trends to Drive PE Deals in 2022
Trend #1 - Strong fundraising and deal activity will continue
Private markets rebounded in 2021, leading to widespread growth across asset classes and geographies. Private market fundraising, deal making and assets under management reached new highs last year while PE has continued to outperform other private market asset classes. From these record highs, it is expected to see many leveraged buyout (LBO) deals and equally strong, high performance in 2022.
Trend #2 - Advancements in sustainability; rise in ESG
Although drivers and regulations of environmental, social and governance (ESG) are still developing, there is a trend towards investors becoming focused on environmental sustainability. 2021 revealed more adviser impacts from climate change across the glob, with real impacts on daily lives, economic activity and asset returns.This has raised the urgency within the industry to take a more sustainable path and decarbonize the global economy by finding greener returns and actively assessing ESG impacts (2022 Private Markets Outlook). As a result, PE funds and investors will continue to incorporate ESG factors into decision-making processes in 2022. Considering climate risk in underwriting as well as investing in climate-tech companies is another way for PE firms to create value. In fact, 79% of global investors believe ESG risks are an important factor in investment decision making.
Trend #3 - The return of private club deals
Many PE firms are bypassing bank financing and instead borrowing from private credit funds. This method of obtaining financing is a more seamless process that allows deals to be executed quickly. Additionally, private credit funds are offering PE borrowers more leverage than what they would receive from bank financing. Therefore, private credit funding of PE transactions is a trend that is guaranteed to intensify in 2022.
(Private equity remains strong: 5 Key Trends for 2022)
Trend #4 - Growth in technology
Further adoption of disruptive technologies such as cloud services, artificial intelligence and more is accelerating everywhere. This growth in technology creates opportunities to digitize traditional firms. This could play a meaningful role in expediting the deal-making process. The acceleration of automation, for example, allows fund managers to be more efficient in activities such as investor and regulatory reporting, analyzing large data sets, record keeping and auditability for private asset classes. Due diligence done remotely is here to stay and it is expected for digitalization to become a constant that will filter into PE in 2022.
Building a Private Market Portfolio
While there is not a specific, consistent methodology to optimize your private market portfolio, there are certain considerations and approaches investors can take to achieve a more desired and tailored outcome that meets your needs. Many growth opportunities and capital formation exist within private markets, which makes it an attractive asset to consider adding to your portfolio. Private markets have continued to outperform public markets, which serves as further encouragement to allocate to this asset class. Knowing where and how to start building your portfolio, however, can be challenging. With any form of investing, there are always risks involved and to reap all the potential benefits of private markets, it is crucial for investors to adopt best practices when constructing their portfolio.
Here are some key considerations to think about before you begin investing:
Map out your Plan
As stated earlier in this post, private market investing has certain financial and timing requirements. As you build your portfolio, it is important to consider your ongoing cash flow requirements and put a plan in place that allows you to reach your target goals.
Capturing the most attractive opportunities requires active sourcing, research and access to leading private market managers. Choosing the right strategic partner can significantly influence the returns you make. Engaging with an expert alternatives team to guide you will further benefit and optimize your portfolio.
Once you have developed and implemented your investment strategy, it’s critical to monitor and assess your underlying investments, to ensure that your portfolio is on the right track. Managing your plan on an ongoing basis will ensure that your strategy and target allocation are in line with your desired position.
Pay Attention to Detail
Operational, tax and legal due diligence are vital areas that require careful consideration and rigorous assessment before committing to any private market investment. Getting these details right before investing in alternatives is crucial, given that the investment structure within private markets offers little option to make any changes after your commitment.
Although investing in private markets can be complicated, when done well, the rewards are worth it. Viewing the alternative investment industry through a long-term lens and focusing on how key trends will drive each investment return, is certainly a recipe for success.
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