Risk management and allocation decisions are a real challenge for asset managers in times of complex market turbulences. The recent sharp rise in inflation, announced interest rate hikes and increased global supply chain problems require a rethinking of the usual allocation.
Contrary to the traditional view that traditional bonds can be viewed as so-called low-risk assets, a trend towards broad diversification is currently more important than ever. In the course of this spread of scattering, we see a continuing trend towards more illiquid investment categories and especially towards private equity.
Private Markets on the rise: eightfold increase in volume within 20 years
The outstanding volume of unlisted investments is around ten trillion euros. These ten trillion euros correspond to around 6.5 percent of the stocks and bonds listed worldwide. Speaking of unlisted investments, about 64% is private equity, 15% real estate, 12% unlisted bonds and 9% infrastructure investments and investments in agriculture and forestry.
Volume has increased eightfold, while market cap has grown 2.8x over the past 20 year. The number of investors in the unlisted segments has also tripled. There are many reasons for this development, but the diversification effect is the main driver. A more diversified portfolio is better protected from fluctuations and negative effects of inflation.
Risk diversification: Institutional investors are increasingly opting for unlisted investments
Thinking of increased inflation, risk considerations gained an new dimension within the past 20 years. Along with the low interest rate environment, this primarily affects asset classes such as bonds that are described as low-risk or defensive.
Investments in private equity offer the opportunity to achieve higher absolute returns and portfolio diversification. Otherwise, scheduling investments in private equity firms can be an advantage. Usually capital providers have two or three years time to invest the funds they received through the investment rounds.
Investments that are not listed on the stock exchange are categorized as “illiquid”. Therefore, they are subject to a different valuation method than liquid instruments. Less liquid investments have become a worldwide trend, especially among long-term investors. Long-term investors mean institutions such as pension funds and insurance companies.
Regulatory simplifications for institutional investors
Market supervisors have done a lot to create relief for illiquid investment categories. In the USA, e.g., private equity fund investments for state-incentivized pension plans in the form of 401 (k) plans for private individuals are possible. The EU Parliament is adjusting the AIFMD and UCITSD directives. This became necessary to react to changed market conditions and to remove barriers to cross-border sales. External capital instruments – e.g. mezzanine or venture debt – should be allowed outside of banks via alternative investment funds. The reforms of the Pensionskassen Act (see Section 25 of the Pensionskassen Act) allow significantly more scope.
Increased demand for ESG investments
Investments that pay special attention to environmental, social and governance (ESG) and sustainability aspects have become a standard in all investment categories. Venionaire Capital already responded to this development. We will establish four partners in leading positions by the end of this year. Additionally we will set up an ESG policy adapted to the business model for our new fund projects. Beyond that, we have a “Climate Tech” related sector fund (Clean Energy, Circular Economy and Green Tech) in the pipeline. This will be exciting in connection with an EU project that is in its final approval phase.
Infrastructure, real estate and the private equity sector are playing an increasingly important role in this context and hold much potential. According to a McKinsey study, fulfilling the energy transition and the path to net-zero emissions by 2050, craves around 3.5 trillion euros annual investments for decarbonization. This equals about one third of the current total market volume of non-listed investments and suggests increased momentum from this sector.
We are confident that private markets will receive increasing attention in the current market phase. Although individual segments, such as real estate, have come under some pressure due to the rise in interest rates. But the corrections that have taken place in some areas offer attractive opportunities for the future.
As a local specialist with niche products, we develop exciting solutions for further diversification away from the global giants. We work closely with our holdings, support growth, create jobs and assist with generational change. Beyond that we see our role in enabling and maintaining European innovation and technology leadership.
Original article was published in German on institutional-money.com