Private assets 4.0: the opportunities in 2022
Private markets have reached a new phase. We explain why, and how investors can benefit in 2022.
Private markets have grown and matured over the last two decades and are expected to represent an $8 trillion industry by the end of 2021. They have grown not only in size, but also in variety, providing investors with a variety of return drivers and risk profiles.
Investors have options from private equity to private debt, real estate and infrastructure and from ESG-aligned investments to sustainability focused and impact investments. Additionally, within each strategy, investors can diversify across a broad range of deal types and sizes, which is what we call the “long tail” of private assets.
The breadth and depth of the private markets also means that investors can be ever more selective. They can target the sustainability and impact profiles that best fit their goals. They can target investment opportunities that meet their unique risk-return parameters.
The pandemic has accelerated the evolution of private markets towards what we refer to as “Private Assets 4.0”. This is the next era for private assets, and includes an increased focus on impact investments and the acceleration of the democratisation of private assets.
As we look to 2022 and beyond, we explore some of the key themes for investors considering allocations to private assets, including:
- The attractiveness of small- and mid-sized deals
- Shift in focus from “illiquidity premium to “complexity premium”
- Risk management – the focus on diversification
- The rise in importantance of impact
- Democratisation of private assets (liquidity options, access options)
Opportunities in harder-to-access parts of private markets
In private markets, one factor that is often overlooked and that investors can turn to their advantage, is that the vast majority of transactions are small and mid-sized deals. They represent 95% of all transactions and 50% of the total transaction volume - the long tail of private assets. It follows that the large transactions – which represent that other half of the market by volume - represent only 5% of the number of transactions.
Given its high number of transactions, the long tail of private assets provides investors with a wider array of opportunities to capture what we call the “complexity premium” – unique skill sets applied to complex investment opportunities.
According to Schroders Capital’s Head of Private Equity Investments, Tim Creed, smaller sized opportunities are where skill and access can make the biggest difference.
“We continue to see healthcare, technology and consumer as the three most interesting sectors within buyouts. Even though competition for such deals has further increased given the boost that the pandemic has given to these sectors, we continue to see attractively priced opportunities in the small and mid-sized segment of the market in these sectors.”
It’s a view shared by our Global Head of Infrastructure, Chantale Pelletier. While the most pertinent themes for infrastructure investors are different, deal size can still affect return potential significantly.
“The energy transition, digitalisation and essential infrastructure are the most interesting sectors within infrastructure in our view. We observe that for mid-sized deals, dynamics are more attractive than for large transactions, both in terms of valuations and spreads and in terms of the ability to deploy capital in a timely manner.”
Global Head of Venture Investments, Steven Yang, echoes those comments and says focusing on the opportunities that require more work leaves less of the value creation to chance.
“Within venture capital, we favor the seed and early stage part of the market where we see more opportunities to capture the complexity premium compared to later stages. We see the most attractive opportunities in new and emerging themes across technology, healthcare, and climate tech.”
The complexity premium; a successful pairing of specialised skills and complex situations
The “illiquidity premium” has long dominated conversations about returns in private assets. But as the market grows and evolves, the way that returns are generated are changing. As fund raising is above its long-term trend for some private asset strategies, this can put the illiquidity premium under pressure. We believe that this is just another reason why in today’s market the complexity premium, more than the illiquidity premium, is of growing importance.
The complexity premium is the excess return that can be captured in private assets when two factors meet. First, a situation arises that is particularly complex in terms of access, risks and opportunity. Second, rare skills are deployed to source, select and negotiate, develop and exit the investment. The nature of the complexity premium differs depending on the type of asset, but both of these things are needed for it to emerge.
Sources of private asset complexity premium
Source: Schroders Capital 2021, illustrative purposes only
Compared to listed investments, skill differences are generally more pronounced in private assets, as access to investments, related information and knowledge is generally much more limited. Within private assets, skill differences become especially pronounced in the “long tail” opportunities, mentioned earlier, where smaller deal sizes can be found in less efficient markets. Those differences create an opportunity for the highest skilled market participants to capture a skill-based complexity premium.
The complexity premium can be captured along the investment process, from sourcing to transformation to exit of an investment. Capturing the complexity premium during the transformation phase relies on the operational capabilities of the fund manager and the management team of the underlying asset.
Global Head of Real Estate Sophie van Oosterom highlights how this delivers value in the case of real estate:
“Within real estate we see the best opportunities in subsectors where we can improve sustainable income and drive value through our operational expertise. This is especially true in the hospitality sector and living sector (including social housing), but also office and last mile industrial/logistics, that benefit from the new trends in working, living and playing.”
The complexity premium can generally be found in more specialised and harder-to-access private asset market segments. Examples include:
- Privately sourced small and mid-sized investments
- Direct lending
- Specialised credit
- Infrastructure and real estate investments
- Emerging and frontier market investments
- Impact investments
- Emerging managers
- GP-led secondaries
- Seed and early-stage technology and biotechnology investments
- Chinese onshore RMB investments
- Collateralised reinsurance investments and life insurance investments
Christiaan Van Der Kam, Head of Secondary Investments, believes GP-led secondary transactions are a clear example of complexity being key to the value opportunity. GPs, or general partners, are the fund managers that form private equity funds with their limited partners (LPs). In a GP-led secondary transaction, a particular asset or pool of assets from an existing fund of a GP, will be acquired by the GP and often a small number of trusted LPs. The transactions are undertaken because the GPs believe the full potential value of the asset(s) may be realised with more time and money.
“We see the most interesting secondaries opportunities in GP-led transactions, which allow fund managers to keep and develop some of their most attractive portfolio companies for a longer time period than they would otherwise be able to do. GP-led secondaries are typically highly complex transactions, involving many different stakeholders, and this creates an advantage for those investors who are already a primary or co-investor in those assets.”
Complexity premium can also be found in market segments and regions that are a less mature. This is the case in Australian private debt, for example, explains Nicole Kidd, Head of Private Debt, Australia.
“As banks are adjusting their risk appetite, there is an opportunity for direct lending to step in and fill the gap. We continue to see attractive direct lending opportunities in the Western world. Additionally, there are especially attractive opportunities in Asia-Pacific, where private debt markets are far less developed than in the rest of the world. For example, Australia is a particularly attractive market for private debt, where both an illiquidity premium and a complexity premium can be captured."
The evolution towards Private Assets 4.0 gives investors additional choices
The past two years have accelerated or intensified trends already underway. As a result, the journey to the phase of the private assets industry - what we refer to as “Private Assets 4.0” – has been sped up.
In this new paradigm, the approach to private asset return generation increasingly focuses on the complexity premium. Risk management focuses on diversification within private assets, including along the long tail of private assets. The impact dimension of investments becomes embedded more broadly and measured more consistently. Finally, new liquidity options (including semi-liquid evergreen structures) drive a continued democratisation of private assets and provide new investors groups with access to private markets that were not able to access the asset class previously.
These elements of Private assets 4.0 are summarised below.
Private assets 4.0
Source: Schroders Capital, for illustrative purposes only
We see an increased emphasis on the complexity premium (as highlighted before) as a key element of the evolution towards Private Assets 4.0 alongside a focus on diversification within private assets.
Insurance-linked securities (ILS) are a strong example of this, with return influences almost entirely removed from economic or corporate events. As Global Head of ILS, Stephan Ruoff, explains, this does not mean investors need sacrifice return.
“We see ILS as a useful tool in the current environment, in part because ILS can provide returns that are uncorrelated to other asset classes. In addition, we are currently in a favourable pricing environment, as risk premiums continue to “harden” (rates are increasing). We expect this hardening trend to continue into 2022, and possibly beyond.”
While private markets have an important role to play with regard to ESG due to the long-term investment horizon of the asset classes, and due to its strong influence on (and often majority control of) the underlying assets, there is now a new push towards generating measurable impact in addition to attractive financial outcomes. Head of Sustainability and Impact, Maria-Teresa Zappia, argues that private asset classes – particularly due to the huge influence of real assets like real estate and infrastructure – have immense power to make positive change.
“Private assets remain core to the goals of actively delivering sustainable and impactful strategies in key areas that affect people and the planet. The way forward is clearly to excel in the measurement and reporting of impact and the implementation of best practices in the investment process.”
The final element of private assets 4.0 that will shape private markets in the coming years is democratisation. Private assets, for all their merits, have in the past been the hunting ground mostly for large, institutional investors.
Even for those intermediaries and their clients that have long been aware of the benefits, options have been limited. This, too, is set to change in “Private Assets 4.0”, as “democratisation” rises in prominence. David Seex, Head of Private Asset Solutions, draws us a picture of what it means.
“Private assets 4.0 means clients are focusing on generating a complexity premium (in addition to an illiquidity premium), as well as seeking better diversification within private asset classes and through multi-private asset solutions. There is also an increased focus on impact (especially related to climate change and based on carbon emission targets) and an interest in innovative structures with new liquidity options that advance the democratisation of private assets.”
This will create new opportunities for intermediaries and for individuals seeking to diversify into, and within, private assets.
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