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Preqin Global Report 2023: Alternative Assets

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Chapter: Alternatives performance continues, but uneven

Macroeconomic headwinds are buffeting private equity, venture capital, and real estate in the near term, but opportunities are still emerging across the alternative asset classes

By Valerie Kor

January 19, 2023

The macroeconomic environment in 2022 was volatile, with inflation, interest rates, and Russia’s invasion of Ukraine derailing markets. But not all private capital asset classes were impacted equally. For private equity (PE) and venture capital (VC), the stimulus-fueled market frenzy of 2021 has died down, leading valuations, fundraising, and deal activity to fall heavily in 2022. PE performance is likely to be impacted by higher interest rates, which will directly affect the performance of leveraged buyouts. VC will experience pressure on returns in the short term, with lower valuations making it more difficult to exit investments profitably, but opportunities still exist to deploy the half-trillion dollars of available dry powder.

As investor caution has grown, we observe a shift in preference away from comparatively higher-risk asset classes such as PE toward the perceived relative safety of real assets and private debt. We expect continued growth in private debt as a result, with assets under management (AUM) forecast to increase at a CAGR of 10.8% through to December 2027. At the same time, we expect that high commodity and energy prices will allow natural resources and infrastructure managers to generate good returns for investors, although these asset classes aren't immune to higher borrowing costs due to rising interest rates.

Fig. 1: Assets under management by asset class ($)

PE to face challenges in 2023

The PE industry may face a shake-up as GPs worldwide grapple with a tougher fundraising environment. As the global economic outlook continues to darken, PE firms will find it harder to deliver returns. Preqin expects annualized global PE returns to fall to 13.5% between 2021 and 2027, compared with the 15.4% per year achieved in the 2015 to 2021 period. Among regional markets, PE funds in APAC are expected to perform least well, with returns of 11.6% over the six years from 2021 to 2027, down from 12.8% between 2015 and 2021. Idiosyncratic risks in the China market, including from a weaker-than-expected economy and regulatory uncertainty, are driving this decline.

2023 may prove a strong vintage for VC

While VC has outperformed PE for vintages between 2009 and 2019, delivering attractive risk-adjusted returns, it remains the most vulnerable alternative asset class moving forward. The near-term outlook for VC is uncertain, particularly for funds which raised significant capital in 2020 and 2021.

That said, 2023 may be a turning point, as valuations have declined and competition for deals has eased, creating more opportunities for VC managers to deploy their dry powder in search of attractively priced, promising targets. Preqin forecasts that the amount of dry powder will increase to $659.1bn by the end of 2027, up from $530.8bn as of September 2022.

Within VC, expansion and late-stage strategies have been the top performers post-global financial crisis (GFC), with a median net IRR of 28.3% between 2009 and 2019, while early-stage strategies have also delivered strong returns (median net IRR of 26.6%) at a slightly higher level of risk (standard deviation of 25.2% compared with 24.0% for expansion and late-stage strategies). Still, the current economic climate is likely to have a greater impact on expansion and late-stage strategies where valuations have been highest, whereas early-stage strategies may be more resilient in the short term.

Fig. 2: Private capital: risk/return by asset class (vintages 2009-2019)

Private debt AUM to outpace other alternative asset classes

Private debt has emerged as a rapidly growing asset class in recent years, with AUM hitting $1.3tn by March 2022. From 2015 to 2021, private debt’s CAGR was 15.7%, the third highest among alternative assets, after VC and infrastructure.

While we anticipate AUM growth for private debt to moderate somewhat, it's still expected to outpace alternatives generally, particularly PE and real estate in the coming years. Total AUM is expected to reach $2.3tn by the end of 2027, increasing at a CAGR of 10.8% between December 2021 and December 2027. With all alternative assets’ AUM growing at a CAGR of 9.3% over the same period, private debt is set to gain overall market share. Despite shifting macroeconomic risks, private debt investors are well placed both to shield themselves from potential volatility and achieve solid returns.

Muted real estate performance

Real estate AUM hit $1.3tn in December 2021 and is expected to increase by a CAGR of 8.4% over the six years to December 2027, hitting $2.1tn. This represents a slowdown from the 9.4% annual AUM growth rate between 2015 and 2021, reflecting the challenging market conditions. Preqin forecasts suggest that annual performance, as measured by predicted changes in the PrEQIn Index across the asset class globally, will be relatively flat at 9.2% per year throughout the forecast horizon.

While real estate’s AUM growth is likely to continue, investors see the asset class as one of the most overvalued, which will affect both fundraising and deal activity. Borrowing costs are rising and patchy occupier demand could worsen if multiple countries enter a recession. On top of that, households have less disposable income to spend in shops or online, potentially affecting retail and industrial activity.

Fig. 3: Investor expectations for the performance of their investment portfolios in the next 12 months compared with the previous 12 months

Infrastructure and natural resources are bright spots

Infrastructure and natural resources were bright spots among the alternative assets in 2022. Investors are increasingly drawn to them for their ability to hedge against inflation, while high energy prices have benefited many infrastructure developers in the energy sector. Telecoms have also seen sustained activity in the deals market, underpinned by demand for bandwidth and resilience as hybrid working becomes more common. Nonetheless, interest rates are weighing on asset prices via the discounting effect, which will impact return generation in the next 12 months.

Most commodities were already in a super-cycle when Russia invaded Ukraine, propelling global energy prices to often record highs. Natural resources fund managers returned a net $22bn to investors for the year ending March 2022, compared with $13bn during 2021, as high prices allowed fund managers to liquidate investments and return capital to investors.

Natural resources topped the short-term performance table across alternatives, posting one-year rolling IRR of 34.6% through March 2022, ahead of real estate at 33.0%, and PE at 29.3%. It was the highest level since Preqin began to publish this index for natural resources in 2009.

Selected hedge fund strategies perform well under pressure

Hedge funds experienced a tough year but managed to bring value to many portfolios. As of September 2022, the growth of the asset class had declined by 9.3% (-12.2% annualized). However, CTAs, macro, and relative value strategies helped to reduce the damage, generating positive numbers for investors in the first three quarters amid market volatility. Multi-strategy and credit strategies still absorbed some of the shocks, while equity and event-driven disappointed many. They still performed better than many parts of the market, however.

Overall, hedge funds endured a tough first half as net capital outflows totaled $24.3bn, and then continued throughout Q3 (-$30.7bn). Lackluster performance, along with the outflows, suppressed the industry’s total AUM in 2022. Based on our last official estimate, AUM stood at $4.1tn as of September 2022, which represents a 4.8% reduction since the end of 2021.

Fig. 4: PrEQIn Index: private capital strategies vs. S&P 500 TR Index (rebased to 100 as of December 31, 2007)

Performance and growth in absolute terms

Performance and valuation changes in alternative assets lag behind the public markets so, given the pain felt by equities and fixed income assets, it's likely that further downward pressure will be experienced across private markets. The next few years will undoubtedly be more challenging than the benign environment over most of the past decade, but it's worth looking at growth and performance numbers in absolute terms. Preqin forecasts that PE, the largest alternative asset class, will deliver an average net IRR of 13.5% and see AUM grow at an annualized rate of 10.2% over the five years to 2027.

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