Private market funds have nearly tripled assets since the global financial crisis — accounting for more than 35% of new capital raised through bonds and equity in the U.S. in 2021 — but the Goldilocks-like market conditions that facilitated this meteoric rise are changing, presenting new risks and opportunities for investors, according to new research from PGIM, the $1.3 trillion global investment management business of Prudential Financial.
In “The New Dynamics of Private Markets,” the latest in PGIM’s Megatrends research series, PGIM finds that tightening monetary conditions and a slowing economy will challenge investors to navigate the increasingly blurred lines between private and public assets, address liquidity concerns and explore newer segments of private credit markets. The paper draws on insights from more than 40 investment professionals across PGIM’s private alternatives, real estate, fixed income and equity managers — as well as over a dozen leading academics, investors and sell-side researchers.
“With the rising possibility of hard landings in the U.S., Europe and emerging markets, this will be the first test since the global financial crisis of whether nonbank financial institutions have diversified risk and brought better market judgment, or created new, hidden concentrations of risks,” said Shehriyar Antia, head of thematic research, PGIM.
WINNERS WILL BE TESTED
New private credit entrants need to prove their mettle in a downturn
As banks and finance companies have withdrawn from riskier segments of lending, direct lending from private credit funds has boomed from less than $10 billion in 2006 to over $400 billion in 2021. However, many newer entrants into private markets haven’t been tested across a credit cycle and may not have the workout and recovery skills of more experienced firms.
AI-powered fintech platforms and short-term credit providers face uncertainty
The last decade has seen a surge of fintech lending platforms that offer unsecured loans to individuals and small businesses, then securitize these loans into asset-backed securities. However, credit losses and charge-offs on buy-now, pay-later loans have already translated into higher funding costs for some ABS issuers, leading to concerns about the viability of the business model.
Direct lending needs to dig deeper for attractive investment opportunities
Private equity, sponsor-backed lending now comprises more than 70% of the direct lending universe. However, most of that is concentrated in larger deals, where capital is ample and competition is fierce. Direct lenders who build relationships with middle-market business owners and carry out bespoke underwriting can create potentially attractive debt solutions in areas where capital is more scarce.
KEY CONSIDERATIONS FOR INVESTORS
“While these new dynamics in private markets will be complex to navigate, they offer a range of attractive opportunities for long-term, sophisticated investors to evaluate,” said Taimur Hyat, chief operating officer, PGIM. “Investors should look carefully at liquidity, secondary markets and private equity sponsor behavior as they navigate these turbulent times.”
Evaluate more flexible investment approaches that span public and private markets
A credit risk approach that looks at private credit separately from public is no longer suitable due to the growing overlap and interplay between the two segments. Portions of the same underlying corporate loan can find a home in syndications, CLOs or even private debt funds. No matter the structure, the growing fungibility of the underlying credit means there may be less diversification benefit from allocating separately to public and private debt.
Develop a more sophisticated understanding of liquidity
As chief investment officers add to their private allocations — for example, U.S. pensions have doubled their allocation to private markets over the past 10 years — many are seeking a deeper understanding of the overall liquidity profile of their portfolio. Secondary markets — which provide liquidity to private market investors — may be a vital portfolio management tool, especially for investors bound by strict allocation targets.
Closely watch maturing new debt asset classes for attractive risk-return opportunities
Newer segments of private credit markets may offer greater opportunities for return in a challenging macro environment. Infrastructure debt remains a growing but relatively underappreciated asset class — especially with the potential for earnings stresses around the corner and bubbles in overheated private equity markets.
Evaluate integrating private alternatives into defined contribution plans where appropriate
Most DC plan participants have a long-term investment horizon that aligns well with the lower liquidity and committed capital structure of private markets. Chief investment officers with oversight over defined benefit and DC plans in countries such as the U.S., U.K. and Australia should carefully weigh the opportunities for responsibly incorporating private market investments into DC plans, just as they have in their defined benefit plans.
“Employers’ defined contribution plans are a great opportunity to democratize private markets investing, allowing individual investors to access the returns available in private assets,” Hyat said. “Private real estate is already available in some plans through target date funds and can provide growth opportunities for younger investors, as well as inflation-hedging and income for those approaching or already in retirement.”