Following a period of huge turbulence across global markets and economies, how has the funds sector performed? And what’s on an upward trajectory as we look forward?
Investors and fund managers have had to deal with considerable volatility and uncertainty during the past 12 months.
The continued impact of the Covid-19 pandemic on supply chains and consumer behaviour, followed by the Russian invasion of Ukraine and subsequent price hikes resulting from a global cost-of-living crisis – not to mention soaring inflation and interest rates in the UK, Europe, the US and beyond – have all impacted sector performance.
On top of all this, a banking crisis that saw the collapse of US group Silicon Valley Bank and the sale of Credit Suisse has also shredded market nerves.
Is cash king?
“It’s been a difficult environment,” says Yulia Manyutina, Associate Director, Climate and ESG, at RBS International.
“Funds are holding on to assets for longer and it is harder to raise money in an increasingly competitive environment. For many investors, it has been more comfortable just to sit on cash. It is seen as the less risky option when looking at returns.”
However, as with most crises, where some investors see red lights, others look for the green lights of opportunity. Even in these troubled times, when the chips are down in one sector, things are looking rosier in others.
Looking at the most recent quarterly statistics from Preqin, this has once again been the case. In its second quarter report for 2023, the investment data group found that private equity buyout horizon internal rates of return – or IRR – were 2.1% for the year ending 2022.
This means these funds managed to tread water over the period, despite the challenges in public equity markets and concerns relating to the state of the global economy – in particular, rising interest rates.
According to Preqin, this prompted fears that valuations are not being marked down to the extent they should have been given steeper declines in public equity markets.
Aggregate capital raised declined 35% to $106.7bn, representing the weakest quarter for fundraising since the second quarter of 2018. After all, uncertainty and deal-making are not natural bedfellows.
Venture capital also suffered, with end-of-second-quarter deal-making trending downward for the sixth successive quarter. Aggregate capital raised has followed a similar trend, with 219 funds raising $26.1bn by the end of Q2 2023.
Private equity and venture capital
Private equity and venture capital are still performing well in the Channel Islands. The most recent Monterey Insight Guernsey Fund Report found that fund assets serviced on the island stood at $517.8bn at the end of June 2022, down just 2.8% compared with 2021.
Private equity/venture capital funds remained the most popular product of serviced funds topping asset allocations with $379.8bn.
In Jersey, fund assets serviced decreased from $605.4bn in 2021 to $585.2bn at the end of June 2022. Again, private equity/venture capital funds were the most popular products, accounting for $415.9bn of assets. Property/real estate funds ranked second, with $72.2bn.
“From a fundraising perspective – private equity houses raising new funds – this has been more challenging, with interest rates on the up and general economic uncertainty,” says James Syrotiuk, Partner at Heligan Group.
“Limited partners are taking longer to commit. Hence, new PE funds that would have historically been raised in 10 to 15 weeks are now taking between one and two years.
“From an investment perspective, deploying the fund when it has been raised into investee companies has also been affected. Deal volumes are down across the board as companies sit tight and PE investors are more wary of relying on historic financial information to value businesses.
“All of that said, those funds with a USP and a differentiated offering stand to benefit as investors seek to put their money into new opportunities and new markets.”
Elsewhere, Preqin said a strong June pushed global hedge funds toward a 2.46% return by the end of Q2 2023. Equity-focused strategies, relative value and event-driven funds performed well.
Private debt is the asset class that has most outperformed investor expectations, with 90% of those surveyed reporting that the asset class had met or exceeded expectations over the past year.
Private equity real estate capital-raising surged to $57bn by the end of Q2 2023, above the $46bn quarterly average achieved since 2018.
However, the number of funds closed fell in the quarter, marking the second consecutive quarterly drop.
Natural resources’ 30.2% one-year horizon IRR was nearly double that of infrastructure (15.9%) and nearly three times higher than real estate (10.6%) by the end of 2022.
ESG funds, according to Refinitiv data, showed a rare net outflow for the first half of 2023. This was due to economic and regulatory worries in Europe and an anti-ESG backlash in the US.
Global ESG funds that invest in shares saw $15.4bn of net outflows in the second quarter. However, ESG fixed-income funds enjoyed net inflows.
Manyutina believes that despite the volatility, the allure and evolution of ESG funds is still clear. “We’ve seen fund managers looking beyond the usual climate change and carbon emission piece towards new areas of ESG such as nature and biodiversity, sustainable supply chains and social aspects such as impact investing,” she says. “A bigger picture is emerging.”
Horizon scanning
As for the vision of the next few months, investors appear to feel more confident that the darkest economic days are over.
According to an August survey from Preqin, more than three-quarters of global investors believe we are on a decline or approaching the bottom of the macro-economic and real estate market cycle.
As a result, only 5% of investors were planning to sell down their private capital allocations in the next 12 months, with over a quarter planning to increase.
Private equity, Preqin added, is set to grow its position as the most-held asset class, with more capital expected to flow into it despite a “more pessimistic returns outlook over the short term” and concerns that it is currently overvalued.
Infrastructure is the asset class that’s set to be second-most popular with investors in the next 12 months, with a particular focus on the US.
The positive trend in private debt is also expected to continue, with most investors tipping it to perform even better over the next 12 months.
Much of the interest in private debt, Preqin added, is due to the current economic environment and concerns around interest rates lingering. Investors point to reliable income as the main reason for investing in private debt, as well as some looking for high absolute returns.
Both private debt and infrastructure are also benefiting from a continued appetite for more stable assets as investors await more certainty from the global economic picture.
Elsewhere, Preqin found that most investors believe the real estate cycle is starting to decline or is approaching the bottom, but that short-term pain awaits. Indeed, more investors are looking to cut their allocations to this sector.
Hedge funds are, however, poised for recovery, with the US presenting the brightest opportunities and the UK seeing a drop in sentiment.
More pain to come
More pain is expected to come in venture capital, with most investors believing their VC portfolio is overvalued. Commodity price concerns are also expected to cloud opinion on natural resources investment.
“Private debt continues to build awareness and ESG/impact is still strong,” says Syrotiuk. “The latter will continue as I can’t see things swinging back away from a focus on ESG – and nor should they.
“So investing in businesses and sectors that have a greater ability to make an impact on ESG factors is a good thing and, in my view, will remain in a growth phase.”
Manyutina adds: “ESG is not going away with a developing regulatory market in both the UK and the Channel Islands. ESG investors have a long-term outlook of 20 to 30 years. They are not held hostage to short-term volatility. I have a strong belief that ESG and impact investing will remain a growing area.”
Syrotiuk also points to sectors such as national security and crime prevention for potential funds growth. “Anything IT or cyber related will be strong,” he says. “We will probably see more investors looking for ‘platform’ assets where they can execute a buy-and-build strategy as opposed to one-off investments. This allows PE houses to get more money out the door in a market where new opportunity is sparse.”
Manyutina says raising funds will remain challenging given competition levels and urges fund managers to be more open and upfront with investors on what they are trying to achieve with their strategies.
“Engage early, be visible and very specific about what you want from investors and why,” she says. “This will differentiate those that will do well in the months ahead and those that won’t.”