While comparatively resilient, private markets were not immune to the wider slowdown triggered by Covid-19. However, despite a dip in fundraising across the industry in 2020 and further economic pain expected in the coming quarters many private market segments will display characteristic stability, while new opportunities for value creation will emerge.

Private equity

Private equity has continued to prove its stability during the pandemic. Although global stock markets corrected by more than 20% in Q1 2020, buyout investments only corrected by about half that amount. Venture capital valuations were even less impacted.

Over the long-term, the world is moving at very different speeds in terms of demographics and growth. Private equity is well-suited to this type of backdrop, given a broad range of different return drivers, which can create value in a variety of ways that we will touch on later. This is especially important in a lower-for-longer interest rate environment.

Private equity is also well positioned to capture secular – or non-economically sensitive – trends, before they are accessible through listed stock markets.

Further, the control nature of the investments and the often-lengthy due diligence process enable private equity to achieve increasingly important ESG and impact-related objectives beyond just financial goals.

Despite these dynamics, excessive capital poses a risk. As more and more investors are willing to accept – or even seek – illiquidity, this premium might be getting smaller.

This requires investors to focus on capturing a “complexity premium”. This can be found in more specialised and harder-to-access segments that reward participation in investments that are hard to replicate. Examples include:

  • Small buyouts
  • Emerging managers
  • Co-underwriting for direct/co-investments
  • Specialised secondaries
  • Turnaround
  • Seed and early-stage technology and biotechnology investments
  • Early growth investments in Asia and Chinese onshore RMB investments

Impact investing

Emerging markets (EMs) have ultimately fared better during Covid-19 than initial fears of the impact from the hit to trade and tourism, plus weaker commodity prices and slower foreign direct investment. Fiscal and monetary policy measures were supportive and limited the immediate fallout. Macroeconomic forecasts now even suggest positive GDP growth in 2021.

At the same time, the pandemic has still increased global poverty and damaged developing labour markets.

We believe well-managed microfinance institutions (MFIs) should be able to maintain required liquidity and capitalisation levels. In some markets, such as India, better performing MFIs may be able to increase market share as demand picks up. In addition, a weaker US dollar may ease debt burdens for countries who borrowed in dollars.

In addition, impact bonds continue to look attractive – in terms of better value - relative to investment grade credit in developed markets. This requires a selective approach, but an ever-wider market in social, impact and green bonds will expand the range of potential outcomes.

With many MFIs now having lower cash reserves than desired, they will look to capital injections to achieve targets; this creates a conducive environment for private equity investments. Beyond shorter term risks on business models stemming from Covid-19, attractive pricing is on offer.

The longer-term themes are also still valid, especially the fight against climate change. Investment in infrastructure development is one of the main drivers of sustainable growth in EMs.

The energy sector, in particular renewables, remains in focus for investors. EM populations, at 65% of the world’s total, are growing rapidly, creating further demand for infrastructure, and of a sustainable nature.

Infrastructure

Covid-19 has magnified and accelerated the importance of engaging with key themes that have supported infrastructure investing – including decarbonisation, digitalisation, the zero-rate environment and a general ESG-conscious investment approach.

Infrastructure will help drive new investment in renewable energy and electric mobility (for example, electric vehicle charging stations). There is also a growing need to improve existing infrastructure via greater efficiency and “smarter” networks.

The pandemic has certainly sharpened the focus on digital infrastructure beyond a “nice to have” towards an essential need in day-to-day life. The digitalisation and “virtualisation” of the economy are also impacting how we travel.

It is notable that infrastructure, with its investment time-horizon of around 20 years, can sustain bumps in the road better than businesses with five-year cycles that are prone to disruptive forces.

Another effect of Covid-19, meanwhile, is ballooning debt, with risk-free rates close to zero, or even negative. In 2021, we believe infrastructure - including senior debt, junior debt and equity - will still offer attractive, predictable and regular cash flows to yield-starved investors.

Click here to learn more about the opportunity sets and solutions of various types of private assets.


IMPORTANT INFORMATION
Investment involves risks. This material is issued by Schroder Investment Management (Hong Kong) Limited and has not been reviewed by the SFC.