Seize opportunities with Alternative Investments - exciting trends and positive outlook
Alternative investments in 2021
The global alternative investment market has not only weathered the storms of the past few years but has emerged stronger than ever. In 2021, private equity (PE) and hedge funds (HF) had another very successful year. Given the strong performance of the asset classes PE, venture capital (VC), private debt (PD), infrastructure and natural resources the corresponding fundraising, investment and exit activities reached new highs. Only the real estate (RE) sector lagged, as shown in the chart below of rolling IRRs with a one-year horizon by asset class.
Investor positioning and outlook
It is always important to remember that unprecedented situations can also present significant opportunities, as resilience is the essence of the free market capitalism system. However, people tend to always underestimate the adaptability of the free market system - simply because most people cannot see how these companies do it. Investors do not need to see how they do it, but they do need to find companies whose managers are able to see how they can best adapt to the current situation in their business and in their environment, with their customers working around their constraints.
In 2021, investors continued to value diversification, high absolute returns and high risk-adjusted returns from their alternative allocations. As a result, (institutional) investors are sticking to their allocations to alternative investments. According to the Preqin Global Alternatives Reports 2022, on average 90% of the investors reported that the performance of their PE investments (PE, VC, PD, RE, infrastructure and natural resources) met or exceeded expectations, compared to 72% of HF investors. However, investors are increasingly concerned about competition for assets, valuations and rising interest rates. Nevertheless, more than a third of the investors (35%) plan to invest more in private capital over the next 12 months, another 51% expect to invest the same amount, and only 14% plan to invest less.
Private Equity (PE)
As a result of many countries' policy responses to the pandemic, PE surged on a wave of liquidity and positive investor sentiment. PE therefore delivered consistently high returns, with an unusually strong upswing in 2021, outperforming both the S&P 500 TR Index and the MSCI World TR Index over the long term. Nevertheless, in many ways the PE industry was never really tested - but the true test may still be ahead. Low interest rates continued to incentivise additional investors, keeping acquisition financing costs low while maintaining high valuation multiples. This means that the outlook for the global PE market - especially compared to other asset classes - remains positive if interest rates remain negative in real terms.
Venture Capital (VC)
VC has been a stellar performer in 2021. VC is attracting investors and supporting promising innovations and solutions to some of the world's most pressing problems. The technology sector continues to be the focus of interest for VC investors. However, investments in decarbonisation solutions constitute an evolving trend within VC. VC has therefore emerged as an important component in institutional investors' portfolios, offering an attractive risk-return profile and high potential - as shown in particular by short-term returns.
In 2022, the growing demand for innovation will drive the total amount of VC raised even higher. Innovations in traditional sectors are more likely to be accepted and adopted today than before the pandemic.
Going forward, investors will need to closely evaluate the quality of the transaction flow of traditional VC funds versus the value proposition of newer niche strategies.
Private Debt (PD)
PD has performed well over the past decade thanks to low interest rates and high demand. Even as it rose through the ranks of private capital accelerated in the pandemic-ridden year of 2020 and into 2021, their place in the portfolio has already been firmly established.
Crucial to PD's success has been, and continues to be, its ability to offer investors low volatility and fixed-income yields that exceed those of the public markets. The role that interest rates play in this area cannot be ignored, despite the floating rate nature of many transactions. Yields, often based on public rates, ultimately depend on where those rates are - and they have been low, especially in the developed world. The low interest rates that have helped the industry to its current form will potentially persist and keep investors looking for returns. As a result, investor risk appetite will remain modest over this period, steering allocations to more conservative direct lending funds, particularly senior tranche strategies. In addition, competition will keep transaction prices high, forcing managers to look more globally in search of better valuations.
Hedge Funds (HF)
In 2021, HFs had another strong year, benefiting from market dislocations. Investor attitudes towards HFs have certainly changed over the past two years. After the global financial crisis (GFC), the industry took a new direction and managers began to focus on risk management. Risk-adjusted performance remained strong but declined as the industry matured. HFs faced significant challenges at the time, as passive public strategies outperformed after the GFC. In due course of the COVID-19 crisis, risk management became relevant again. Positions taken by institutional investors paid off when the asset class protected them from massive setbacks and allowed them to participate in the recovery. Importantly, HFs perform well under market stress as they can profit from dislocations, of which there are still many – apart from the current geopolitical disruptions. 2022 will be a year of transition as central banks gradually withdraw from markets. HFs are well positioned to continue their strong momentum in 2022 and navigate the changing environment.
Real Estate (RE)
After a difficult 2020 for RE, 2021 proved to be another year of consolidation. 2021 showed a light at the end of the tunnel after having a relatively slow start. In 2022, the upswing in fundraising should continue as capital is deployed through a growing number of increasingly large portfolio deals. However, there are also challenges in the RE sector. The fundraising activity seems to be relatively weak, the outlook may not be as rosy as it was at the beginning of the last cycle as illustrated in the case of retail assets. Retail assets continued to suffer from comparatively weak demand. The pandemic has exacerbated many existing structural problems in the retail sector. With more and more of us preferring to shop online rather than in person, it may take some time for the fundamentals of the sector to recover to the point where investors are ready to return in a big way. Despite these challenges, there are bright spots and a potentially positive years ahead. Should the macroeconomic environment remain favorable and interest rates remain low relative to historical averages, the RE asset class can continue to thrive.
Unlisted infrastructure is sought by many investors for its stability in the face of economic upheaval. By providing the most crucial services required to underpin economic activity, infrastructure is able to ride the ups and downs. Looking back over the past two years, the asset class has certainly achieved this. As inflation continues to rise across many regions, investors may look toward slightly riskier strategies to improve real returns. However, investors should be careful about taking the infrastructure inflation hedge proposition at face value. Not all infrastructure assets demonstrate the inflation-hedging characteristics that have become synonymous with the asset class.
The recovery of natural resources from the COVID-19 pandemic is gaining momentum as inflation concerns and the prospect of a new commodity super-cycle fuel the asset class's recovery. The performance of natural resources is starting to show signs of moving in the right direction, despite being the hardest hit at the height of the pandemic
The fundraising market in 2022 will be crowded. By the end of 2021, a record number of listed commodity funds were on the market. While it is always encouraging to see more funds coming to market.
For natural resources, however, it is promising that recent data suggest investors are once again backing the asset class.
Growth forecasts – AuM in 2026
From 2015 to the end of 2021, AuM across all alternative asset classes increased at a compound annual growth rate (CAGR) of 10.7%. As of the end of 2015, AUM stood at $7.23tn, rising to USD 13.32 trillion (tn) by the end of 2021.
Preqin predicts that the AuM in alternatives will continue to grow strongly from USD 13.32 tn at the end of 2021 at a CAGR of 11.7% to USD 23.21 tn by 2026. PE (2021-2026 CAGR of 15.9% vs. 10.2% for 2010-2020), PD (2021-2026 CAGR of 17.4% vs. 12.8% for 2010-2020) and Infrastructure (2021-2026 CAGR of 16.6% vs. 15.9% for 2010-2020) are expected to have higher CAGR than before. RE, natural resources and HF AuM are also expected to continue to grow over the next five years, but at a slower pace compared with the years 2010-2020.
All this shows that investors feel safe and comfortable with their alternative investments. Furthermore, it has been shown that the confidence-building measures of recent years for the alternative investment industry and the corresponding trust of investors and other stakeholders have been confirmed in the past crisis.
If the alternative investment industry wants to continue meeting investor expectations, it must continually adapt and evolve. However, this should not be a cause for concern: alternative investment managers have shown a remarkable ability and propensity to seize opportunities and minimise risks in challenging circumstances.
As described above, alternative investments represent attractive opportunities for investors, but they require full understanding. It is important to consider tailor-made structures and asset class specific needs for such complex investments and to include lean configurations. It is also essential to have a flexible workbench to further strengthen the substance and stability of alternative investments. VP Fund Solutions is a strong partner with the necessary understanding and many years of expertise to take advantage of the opportunities offered by alternative investments.