The asset management industry is always in a state of flux and recent developments in this sector are no exception. One of the most significant ongoing trends is the current interest rate cycle, which has had a profound impact on private markets, says Andrea Lennon, Country head Ireland, Crestbridge.
Private markets experienced considerable shifts in 2022 as central banks raised interest rates and grappled with global inflation. After positive performance in 2021, the first half of 2022 nearly matched the previous year's returns. However, the second half saw a substantial decline in deal volumes and lending, leading to a drop in valuations and performance. Despite this slowdown, private markets continued to outperform public markets, according to industry benchmarks, which can be attributed to resilient portfolios, adept timing and managerial expertise.
This performance led to a larger allocation of private markets in institutional portfolios. The Crestbridge Asset Management Mood Index (CAMMI) suggests that allocations to private equity and real estate asset classes in the UK and Europe are projected to increase overall in 2023. Private debt and growth capital indices stand at 71.43 and 66.67 respectively, according to participating asset managers.
A report from McKinsey revealed a 26% decrease in private equity deal volume, amounting to $2.4trn, and a 20% drop in real estate deal volume. Global private markets fundraising saw a decrease of about 11% to $1.2trn, largely due to rising inflation and interest rates. On a global scale, fundraising results varied, with a 2% increase in North America, a 39% decline in Asia, and a 28% fall in Europe. In this dynamic, the larger, well-known funds typically benefitted, while smaller firms faced challenges.
Nonetheless, the current interest rate cycle has proven beneficial for venture debt. This lending strategy targets start-ups and small businesses with long-term growth potential. Others can capitalise on lowered asset valuations. For example, entry multiples in private equity buyouts dipped slightly, indicating a decrease in acquisition costs. Moreover, a stronger economy and a more stable investment climate arising from interest rate cycles provide a conducive environment for startups to thrive and expand markets, thus improving the risk-return profile for venture capital firms and their investors.
Higher interest rates also significantly impact the mergers and acquisitions (M&A) sector. They increase the cost of debt, limiting the amount a company can reasonably borrow to finance an acquisition, thereby curtailing the size and pace of M&A transactions. Nevertheless, astute managers can navigate this landscape using equity-based financing, among other alternative financing structures.
Innovative frameworks in the financial sector are boosting the access to private equity funds
Recent innovations in the sector are also reshaping the landscape, such as fund administration and Irish Limited Partnerships (ILPs). A Hamilton Lane report states that private assets generated a 33% premium over public assets, making private equity an attractive asset for individual investors. However, private assets come with challenges like less liquidity and transparency, and higher minimum investment thresholds, making them primarily accessible to large institutions.
Nevertheless, the industry is leaning towards democratising private equity through Long-Term Asset Funds and similar structures. This shift is aided by fund administrators who provide investor-related services and compliance and regulatory support. New digital platforms offering user-friendly interfaces and online tools are revolutionising the investment management space, paving the way for low-cost and self-managed fund options.
The 2020 amendment to the Irish Limited Partnership Act is gaining traction among managers. This hybrid structure combines the advantages of limited partnerships and corporate management structures, making it a preferred choice for various investment strategies in Europe. The Act's reforms allow for easier migration in and out of Ireland and the amendment of the Limited Partnership (LP) and fund jurisdiction by majority vote.
Following the amendment, more than 30 ILPs have emerged on the market. Ireland's favourable regulatory environment, Brexit, competitive tax rates, treaties, provisions and networks, as well as the country's established reputation in the financial services industry, have contributed to the popularity of ILPs within the sector.
For U.S. managers, the lure of the EU market, regulatory alignment offered by the ILP, and Ireland's tax provisions and operational expertise have made ILP a favoured structure in Europe. Nordic managers are drawn to ILPs due to the collaborative ecosystem between Ireland and the Nordic region, the Nordic region's expertise in alternative structures, and ILPs functioning as a vehicle for more investors and diverse portfolios. These managers have also brought their international investor networks and knowledge, providing credibility and confidence to the ILP landscape, leading to increased interest, allocations, and capital flow.
The future of financial markets and private equity
The financial sector is a challenging terrain to navigate. Central Banks' recent increases of interest rates and new legal frameworks for the financial sector in specific countries have ushered in substantial changes affecting funding dynamics and the shift towards the democratisation of private equity. These developments warrant careful monitoring for potential risks. However, they also carry the potential to establish a more stable investment climate, contributing to overall growth, diversification, and democratisation of some of the most profitable and promising segments of the private markets.
Despite the complexities involved, particularly around investor protection, financial literacy, market dynamics and regulatory frameworks, these shifts herald a new era of opportunity in the asset management sector.
By Andrea Lennon, Country head Ireland, Crestbridge.
