Private assets in 2020: What next?

Interest in private assets will continue to grow over the next year. Schroders’ experts across private equity, private debt, real estate, infrastructure and insurance-linked securities, highlight what to expect.

Georg Wunderlin, Schroders Global Head of Private Assets, commented:

“Schroders’ latest survey of global institutional investors shows that private assets comprise around 10-15% of institutional portfolios. However, most expect the allocation to rise over the next three years.

This makes sense to us. At a time when macroeconomic and geopolitical concerns are increasingly on investors’ radars, private assets can offer meaningful diversification and compelling returns.

The rise in interest does pose its own challenges. Increasing allocation has led to concerns around pockets of high valuation. We believe in the coming year that client focus should increasingly be on diversification, operational expertise and the ability to access underserved parts of the market.

As ever, patience and attention to detail should not be overlooked, and the most diligent investors will be best rewarded in coming years. With a deep history in private assets, but the agility to capitalise on value opportunities, Schroders has a distinctive platform for investors seeking to expand in this space.”

Private equity

Nils Rode, Chief Investment Officer, Schroder Adveq, commented:

“We believe private equity’s importance as value creator – for the real economy and for investors alike – means it remains on a long-term growth trend. Nonetheless, shorter-term interest in private equity has been gathering pace in recent quarters. Despite our long-term optimism, this increased pace of capital flows has created a ’frothy’ environment and some challenges for investors.

Today, for example, large buyout fundraising is significantly above its long-term trend, although to a lesser degree than the troubled 2006-2008 vintage years. Furthermore, pre-IPO stage companies with $1 billion+ valuations – so called ’unicorns’ – have mushroomed in recent years. The private valuations of many of these companies have been driven so high that they have ultimately disappointed when an exit into public markets has been sought. For example, Uber, Lyft, Slack and Pinterest, all darlings of the private world, are now trading below their IPO prices.

In contrast, small/mid buyouts in the US and Europe, start-up investments globally and early growth investments in Asia, fundraising trends have been stable or even been declining. This is a positive indicator for vintage year return expectations. One consequence of these diverging fundraising trends is that acquisition multiples for large buyouts have risen to historically expensive levels. By contrast, small buyouts have remained more reasonable.”

Private debt/direct lending

Ji-Eun Kim, Head of Private Asset Manager Solutions, commented:

“Private debt has been one of the fastest growing asset classes in private assets. Sovereign wealth funds and large state pensions were amongst the earliest adopters, but increasingly the rest of the institutional investor world has followed suit.

Private debt’s self-liquidating characteristics and enhanced cash yield are especially attractive in a low-return environment. In addition, the withdrawal of banks from loan activity after the financial crisis, along with more mature relationships between companies and direct lenders, has led to a wider array of opportunities. However, the growth has attracted new lenders, increasing competition and a build-up of dry power. Caution around less favourable pricing and credit terms has risen.

Though 2019 saw easing of senior loan issuance globally, the market remained borrower friendly and expected to be so in 2020 given the competition among lenders. With pressure to deploy capital increasing amid signs of slowing economic growth, we believe investors need to prioritise manager quality and maintaining diversified private debt exposures across regions and industries. Investors should also seek lenders with differentiated origination approaches – the type and source of the loans – and scrutinise their credit expertise and underwriting practices to gauge a portfolio’s resilience in a downturn.

As a relatively young asset class, many private debt managers did not exist prior to the financial crisis. Lenders with a track record of working through market stress, with the organisational infrastructure and scale to shift resources for troubled investments, are more likely to deliver during the next down cycle.“

Commercial real estate

Duncan Owen, Global Head of Real Estate, commented:

“One of the striking features of European commercial real estate at present is that values in different sectors are not just moving at different speeds, but in opposite directions. Investors must follow not one real estate market, but instead several. The biggest divergence is between retail and warehousing (industrial). Indeed, market fragmentation – a key theme of 2019 – is something we expect to persist next year.

In Europe, we continue to like office space in ’winning’ cities; those with diverse economies such as Amsterdam, Berlin, Copenhagen, Paris, Munich, Manchester, London and Stockholm. Vacancy rates in many of these cities are at their lowest in 15 years and although development is increasing, it is unlikely to halt the growth in office rents. London faces some uncertainty due to Brexit, but there our strategy is to focus on areas which have a bias towards tech, media and life science occupiers – such as Bloomsbury and Shoreditch.

The retail sector is difficult. The real opportunity is to convert redundant retail space into other uses including hotels, offices and residential. That should be viable in locations where there is demand from competing uses. We see good potential to re-develop old stores in city centres and retail parks in affluent parts of southern England. It will be much more difficult to re-purpose secondary shopping centres in towns and cities with weak economies.

In the US, we believe a key market theme will be the move from ’big to small’. Property markets outside of the “Big 6” (Boston, New York, Washington DC, Chicago, San Francisco, and Los Angeles) should provide a primary source of stable income growth and protection from overvaluation concerns. Performance differences will be driven, in large part, by migration and demographic trends and corporate economic development, combined with existing positive commercial real estate fundamentals.”

Infrastructure

Charles Dupont, Head of Infrastructure Finance, commented:

“Given the backdrop of weak economic growth – and elevated public market valuations – investors are increasingly engaging with assets supported by long-term structural trends. This aligns well with infrastructure, as an essential element of the economic and social revolution taking place in Europe.

For a long time, investors have viewed infrastructure investment as limited to maintenance work in developed countries. The market was said to be mature, and the demand for financing seemed to be falling. Yet in recent years, this apparently dusty asset class – far from the glamorous world of tech start-ups for example – has begun to attract attention.

The energy transition, tackling urban mobility and the digital revolution are all fuelled by ’brick and mortar’ investments that large private capital companies help to finance. Intelligent energy networks are capable of accommodating new green electricity production or erasing peak hour demand. New car parks can make it possible to preserve city centres for pedestrians (who can also share ’on-demand’ vehicles). Fibre optic cables and green data centres can make all-digital networks for the new generation possible.

The image of infrastructure is being modernised, in part as its managers get a little younger. But beyond the asset class’ importance in modernising and connecting societies, we also believe infrastructure is increasingly being framed as a socially-responsible investment. For centuries, infrastructure investment has been at the centre of society’s progress.”