After experiencing a standout year in 2021, the private markets industry encountered a year of contrasts in 2022. The initial months remained strong, but the latter part of the year saw a slowdown. This decline was attributed to factors such as reduced debt availability, increased debt costs, and fluctuations in asset prices. Additionally, many Limited Partners (LPs) grappled with overallocation in their institutional portfolios, leading to the denominator effect. These elements contributed to a year-on-year reduction in both deal volume and fundraising. Contrastingly, there was a notable increase in dry-powder reserves. When examining different asset classes, private equity and real estate faced more significant challenges in 2022 compared to private debt, infrastructure, and natural resource strategies.
Certainly, there are four key observations. Firstly, despite a generally optimistic attitude about the future of alternative investments, there's a noticeable delay in developments compared to what was initially anticipated. While some predicted the debt market would rebound in early 2023, leading to increased deals and lower multiples, these changes are unfolding more slowly than expected. The medium- to long-term outlook remains upbeat, yet there's a slight uncertainty about the time frame for these changes within the industry.
Secondly, the industry's current state presents varied realities, making it challenging to provide a singular overview. Notably, consolidation is evident, with a clear performance gap between the best and worst performers. For midsize funds, especially those with a less impressive track record, fundraising is becoming increasingly difficult. In contrast, top-performing funds, typically larger and fewer, find fundraising less challenging.
Thirdly, distinct differences are emerging across geographies and asset classes. Europe, for instance, lags in areas like venture capital and growth, while Asian and North American markets are experiencing growth with increased investments in these categories. There's also a rising interest in infrastructure investing and private credit as banks reduce their corporate debt exposure. In the realm of liquidity solutions, secondary markets are gaining traction with a growing pipeline and deal flow.
Fourthly, firms are shifting their focus towards more intensive portfolio management and related asset types.
In a study conducted a few years ago, it was discovered that the primary driver of returns was the actions taken with an asset during its holding period. Increasingly, there's a heightened focus on portfolio management and enhancing performance during this phase. We're observing many funds, previously without strong operating-partner divisions, now establishing them. General Partners (GPs) are actively managing their portfolio companies more than ever. They are also concentrating on various new aspects, such as data analytics, sustainability, cost efficiency, and resilience.
Asia has become the world's second-largest private market region, valued at $2.5 trillion, overtaking Europe’s $2.3 trillion. In particular, the venture capital and growth sectors in Asia are the largest globally, surpassing those in North America. Despite the general slowdown in deal numbers and fundraising, we’re witnessing substantial enthusiasm and activity in areas like infrastructure, environmental, social, and governance (ESG) themes, and the energy transition in Asia. The funds focused on the ESG agenda have now exceeded $100 billion in global assets under management.
Investments are increasingly shifting from traditional energy sources to greener alternatives. This includes creating new forms of energy sources, such as converting refineries into ethanol plants. There’s also a focus on developing and scaling new environmentally conscious businesses from the ground up. Investments in enabling technologies are also on the rise, ranging from energy technologies to trading platforms.
Moreover, in response to the challenges facing the global supply chain and the shift towards an energy transition, efforts are being made to optimize key elements of the supply chain and promote investment for creation new sources of energy. Essentially, Asia, comprising both developing and more developed nations, is witnessing significant investment activities in these areas.
Prior to the recent banking challenges, North America's private markets seemed to be entering a new phase. There's been an uptick in new initiatives, particularly in sectors like aerospace, defense, healthcare, life sciences, consumer goods, and specific areas of financial services, especially payments. The market had previously seen a downturn in activity and participant numbers, but we've observed a revival in both aspects.
Currently, we're assessing the implications of the banking issues, especially regarding interest rates and debt availability. North America is likely to see an increase in private-credit opportunities.
Fundraising in North America has been challenging. The actual difficulties might seem more severe than the numbers indicate, partly due to the changing dynamics between Limited Partners (LPs) and General Partners (GPs). Despite the data indicating relative success for larger North American funds, it's been a tough period for GPs.
Many inquire about the banking sector's influence on private markets and the resumption of deal activities. From my perspective, there are early positive signs, including more client interactions and asset-focused activities by managers.
In Asia, private-market fundraising has declined annually since its peak in 2017. This trend, particularly evident in China, should be viewed in context with the existing dry powder. Excluding China, fundraising in other Asian regions has been stable or positive.
The decrease in China can be attributed to three factors: the focus on deploying existing capital and regulatory changes in 2018 restricting non-financial entities from investing in private equity.
Although fundraising has decreased, the alignment of valuations with long-term trends and the reduction in entry multiples from 14-15 to 11-12 indicate potential for increased deal activity in the future.
It's also notable that larger funds have been more successful in fundraising, reflecting a shift in what constitutes a 'megafund' – from over $1 billion previously to now over $10 billion.
2022 marked another significant year for ESG-focused initiatives in private markets, with substantial investments in ESG-specific strategies and traditional funds shifting towards ESG-friendly approaches. Europe has been pivotal in driving this trend.
Last year, sustainability-focused deals in Europe surged by 7 percent, reaching nearly $200 billion, with venture capital transactions accounting for 40 percent. The escalation of ESG-related actions is driven by the current macroeconomic climate, geopolitical tensions, and heightened energy costs, necessitating a shift towards alternative energy sources and greater energy independence, which in turn demands significant investment.
Regulatory support is also contributing to this growth. The Inflation Reduction Act in the US and Europe’s investment in green industry transitions are spurring fundraising and deal activities. European General Partners (GPs) have been integrating ESG considerations into their corporate policies, operational procedures, and investment decisions, with Limited Partners (LPs) emphasizing these aspects in capital allocation.
Interestingly, there's a noticeable correlation between ESG topics and financial performance, contrary to common belief. Funds are increasingly focusing on value creation and asset planning, where ESG factors are key performance drivers.
This trend is expected to expand, with more companies striving for green transitions and requiring capital, either equity or credit. This shift presents significant opportunities in the industry to support client transitions during this period.
Reflecting on the industry, it is preferable to analyze annual fundraising rather than total assets under management. Over the past decade, this figure has tripled, and it is anticipated that this growth will continue across buyouts and growth equity, with venture capital also expected to follow suit.
In the short term, the market seems to be moving towards a more typical transactional environment. We're witnessing an uptick in buyout activities and a growing interest in complex transactions like carve-outs and take-private deals. There’s an anticipation of adjustments in asset prices to align with a prolonged high-interest rate environment, but the necessity for deal-making volume to resume is evident. This industry thrives on asset turnover, and we might see extended holding periods compensated by a stronger focus on generating alpha within portfolios. While it’s challenging to predict overall returns, the software-based investing market, though slower to recover, is likely to rebound vigorously.
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