Institutional money staying invested in private markets, but say valuations need to adjust: survey

INSTITUTIONAL investors believe private equity (PE) valuations need to adjust to market conditions, with half the respondents in a survey citing this as a major concern when investing in private markets.

Respondents to the State Street private markets study also acknowledged rising interest rates would reduce the attractiveness of the highly leveraged asset class, but the majority also expect tough times to bring about buying opportunities.

Nearly 70 per cent of the 480 institutional investors polled – including traditional asset managers, private market managers, insurance companies and asset owners – are planning to stick to their target allocations in private markets despite headwinds.

The study, published on Monday (Feb 6), surveyed investors across North America, Latin America, Europe and Asia-Pacific from September to November 2022.

Eric Chng, Asia-Pacific head of alternatives segment at State Street, said portfolio companies showing the greatest valuation declines are led by the venture capital strategy.

But there are still growth opportunities in other private market assets, and investors are rebalancing.

“That’s why we don’t see a fall-off in investor dollars,” he said, adding that there are also investors allocating to private markets for the first time – a trend more prevalent in Asia.

Three-quarters of the survey respondents said tougher times bring opportunities to grab assets at a discount.

But one of the biggest concerns was that valuations have not yet adjusted sufficiently downwards. This view was more widely held by traditional asset managers, as well as asset owners and insurers.

Chng noted that the market is at an inflection point at which valuation has become more important.

“Every single deal that we’re seeing in the region, and for that matter globally, the general partner (GP)...researching and doing due diligence on the deal has focused more on what is driving that valuation,” he said.

This also marks a shift from a few years back, when investors were “begging” for allocations to top PE funds.

The survey found nearly half of institutions have implemented changes to their vetting processes over the year amid deal quality concerns.

While dry powder globally remains high, some funds may also be facing liquidity challenges. This could drive a secondary market trade cycle with discounted valuations.

“It may take the next six months to 12 months to play out,” Chng said, adding that this could be triggered by GPs with a limited track record who bought assets at higher valuations than they should have.

“A lot of GPs that came in over the last five years… those who are only in Fund I or Fund II, maximum, I think you are going to start seeing those GPs get desperate,” he said. “The weaker GPs will start to discount assets away, and even shut down their funds altogether.”

Real estate was the least favoured private market asset class in the survey: 33 per cent said they expected to decrease their proportional asset allocations to real estate, compared with 28 per cent who wanted to raise their allocations.

The results echo a trend reported in the media, with PE giants such as Blackstone and KKR having to limit withdrawals from their real estate investment trusts as withdrawals crossed limits.

Meanwhile, respondents indicated a preference for infrastructure assets: 41 per cent see an increase in allocations versus 11 per cent seeing a decrease.

Chng noted that a rising rate environment has made it more costly to fund buildings such as offices or malls, which form the backbone of real estate strategies. Shifting work patterns, with more working from home, have also hit pricing power for landlords.

Infrastructure, on the other hand, is drawing more inflows from private capital, shifting away from more traditional bank financing, Chng noted.

The growing environmental, social and governance (ESG) movement has also led to more investors paying attention to infrastructure assets that deal with climate change, such as solar farms.

“You have a whole universe of opportunities that are very ESG driven today when it comes to infrastructure, and that resonates with investors,” he said.

Private equity is expected to continue as the top alternative asset class for new investments over the next two to three years.

Within Asia-Pacific, 69 per cent of institutional investors anticipate making it their largest allocation in private markets over the next two to three years – versus 63 per cent of global investors.

Investors in the region were also more likely to see opportunities in private credit, with half of Asia-Pacific institutional investors indicating it as an area of focus, compared to 43 per cent and 40 per cent of the investors in the US and Europe, respectively.

Chng said: “As Asian investors seek returns and diversification, their attention has turned to private credit. With less competition compared to the US and Europe, private credit in Asia offers more relative value.”