Asset Class Outlook July 2024
Below we provide some detail on the outlook and opportunities across some of the private asset classes we cover.
Real Estate
Vendor expectations have ‘caught down’ to buyers as capitalisation rates have risen across all major property sectors. Some further adjustment to valuations is possible across the real estate sector, as repricing usually lags listed markets and multiple headwinds continue to impact the asset class.
We see that there is still a window of opportunity to purchase high-quality assets at discounted prices, and often below replacement costs. We believe that asset selection remains critical and investors looking to deploy capital should consider higher-grade properties, niche sectors and / or those with restricted supply.
Our sector preferences have not changed and include logistics and industrial assets, single-family rentals, self-storage, healthcare, and childcare centres. Retail selectively looks attractive and office is showing some signs of bottoming.
Over the long term we see factors like demographic shifts, changing supply chains, and the transition to a low-carbon economy driving performance. These considerations should be integrated where possible to future proof portfolios.
Private Equity and Venture Capital
Over the past decade, private equity (PE) performed well on the back of lower interest rates and multiple expansion. Going forward, we believe a focus on value creation through operational enhancements to drive profitability growth will be crucial for PE investments.
Fund raising has been particularly slow but showing some signs of life with increasing corporate advisory engagements on potential mergers, acquisitions and initial public offerings (IPOs). Some of this has been triggered by the recent successful IPO of Guzman y Gomez in Australia. There are signs of improvement in the US, Europe, and Middle East. The slow volume in 2022 and 2023 of public and private exits has meant that distributions back to investors has slowed dramatically. Part of this was a cooling of valuation expectations. Secondary market activity is picking up as fund managers and investors look to create distributions by selling some later stage investments from their funds and portfolios. Funds with less frothy valuations in mid-cap and early to mid-stage growth companies have been less impacted. Opportunities for investors include secondary funds, co-investments and new money into direct funds. Access vehicles for the wealth management segment are being created with open-end fund variants finding strong take-up.
We will seek select opportunities in secondary funds, co-investments and open-ended funds in the quarters ahead.
Private Credit
Private credit remains attractive to investors, with higher overall returns and many funds offering floating rate yields and some offering protections of minimum interest rate floors. Flows into the sector have been encouraged by banks continuing to pull back from areas where they face higher regulatory capital charges including lower quality residential loans, commercial real estate and corporate lending. There are many businesses across the spectrum of size and industries that are seeking financing, particularly those mid- and smaller-sized businesses that are not able to issue bonds in public markets. Direct lending has long been a feature of US debt markets with a combination of bank syndicated loans that are tradeable and individual or smaller ‘club loans’ undertaken by one or a handful of non-bank lenders. Australia is a less mature market and is still developing having expanded rapidly following the Financial Crisis of 2008.
There has been some criticism in the press of Australian private debt, some comments do ring true regarding the still developing nature, and pockets of stress emerging. However, there is excellent opportunity for well-disciplined fund managers to address these markets selectively and for wealth firms to research and select the best risk-managed firms and strategies. There is concern about rising company insolvencies, however the cycle pre and post Covid-19 means some companies are failing now because their life was extended with COVID-19 government grants and loan forbearance by banks, both of which have ended. Good fund managers and strategies will both avoid more cyclical businesses and industries and will undertake thorough credit research to choose better borrowers. Fewer but better fund managers will have had some ‘workout’ experience and be fast to act with borrowers to seek solutions before a default occurs, and act to protect capital if a default becomes more likely.
We see plenty of opportunity to select best-in-class strategies and avoid most which aren’t up to our standards. Performing credit is the most appropriate place to be at the moment and there are better protections and yields for investors in middle-market and lower-middle-market lending. We seek evidence of strong collateral backing through tangible property and real assets, equipment, intellectual property and long-term contracts with customers.
Our approach also enables us to represent investor interests actively with greater transparency of fund manager portfolios and access to the senior fund managers on a regular basis. In some cases we have access to observer rights on investment committees, and have negotiated improved terms in offer documents. This is very different to most other wealth management firms who take what they can get without deeper due diligence or wider understanding of comparable funds.
Infrastructure
Private infrastructure assets emerged from 2023 having undertaken some valuation adjustment and a soft transaction environment. The first half of 2024 has seen valuations resume an upward trend as many revenues have been linked to CPI and patronage of assets has improved.
We think infrastructure assets with a reliable customer base, strong market position, and contractual and regulatory cashflows provide both a downside protection in uncertain times and a way to gain exposure to secular long-term trends. We also see improvements from capacity expansion and operational improvements, identifying middle-market opportunities. These characteristics help add inflation hedging resilience to portfolios.
Choosing the right assets is one of the critical tasks. When we look at assets, we prefer direct inflation linkages, lower dependence on the economic cycle, and either strong market position or protection from competition by regulatory or contractual protections. We also consider valuations against growth potential. Infrastructure strategies we prefer have enhancements in returns from some green-field and brown-field expansion and supportive thematics such as energy transition, cloud computing and AI.
Agriculture
Adding allocation to agriculture into the portfolio provides diversification of return sources and adds long-term growth potential. The asset class is set to benefit from long-term secular trends, particularly those related to demographics and food security. Agriculture can combine multiple aspects There are a range of strategies we continue to monitor and add to selectively, that involve single or multiple aspects of agriculture related land, business, technology and water, each with their own unique characteristics that could provide diversification and long-term returns. There are benefits of agriculture from ‘natural growth’ and ‘natural diversification’ as well as strong inflation linkages and diversified return drivers to financial market investments. We observe recent influences such as the Federal government’s water buy-back scheme influencing inputs into agriculture, highlighting risks and opportunities.