2023 ought to be a year of transformation.
A variety of steps can be taken by wealth and asset managers to enhance performance and capitalize on disruption.
Although inflation may be beginning to decline in 2023, interest rates will still be high, which may cause liquidity issues in the banking sector. There is still a chance of a recession. These difficulties are actual, but as volatility persists and values become more alluring, we anticipate new chances in the private sector this year. Additionally, we see an opportunity for funds that are only now debuting to have substantial relative returns as time goes on.
There are other factors at play in disruption than short-term fluctuations in inflation, interest rates, and asset values. The exit from the current instability will take us into a changed world, creating new threats—and great opportunities. This is because the long-term change drivers are accelerating. Future investing markets will be considerably different from earlier ones. The following fundamental factors are altering the investment outlook:
- Nationalist sentiment and deglobalization: The epidemic, along with escalating geopolitical conflict, has undone the significant progress made towards economic integration over the past 20 years. The connections brought about by globalization will continue to develop and endure, but an appetite for enhanced strategic independence and resilience within nations may hinder cross-border trade and drive up the cost of labor, goods, and commodities.
- Population aging and healthcare: By 2050, there will be an estimated 2.5 billion people in the world who are 60 years of age or older, compared to a billion in 2020. Higher lifespan is straining retirement plans and making healthcare systems more costly in many economies. China and other nations like it are experiencing a demographic deficit, whereas young African nations and the likes of India are anticipating a dividend from population growth.
- Gender restructuring: According to research, by 2030, a majority of the world's wealth will be held by women. This trend is being accelerated by changing demographics, social and economical developments, and family planning.
- Migration and rapid urbanization: By 2050, approximately 70% of the world's population is expected to reside in urban regions. Future infrastructural needs and individual monetary requirements will be greatly impacted by internal rural relocation and cross-border economic relocation.
- Climate change and sustainability: By 2027, More than half of consumers will base their decisions on environmental, social, and governance (ESG) data. The need for sustainability is rising. The general trend is obvious, notwithstanding skepticism in some markets (including political resistance in US territories like Texas and also West Virginia) and temporary challenges brought on by the spike in oil costs in 2022. The primary motivator is climate change, although other objectives, such biodiversity, are becoming more significant.
- Technology and creativity: Over the coming years, we'll witness rapid advancements in areas like artificial intelligence (AI) as well as additional instruments that make use of the data tidal wave (more data was produced in the past couple of years than at any other time in history), new investment concepts like nuclear fusion and environmentally friendly hydrogen, and the growing possibility that quantum computing, the metaverse, and Web 3.0 will completely transform how we live.
Financial pressure is extremely high for asset managers.
The operation of asset managers financially was severely impacted by the interruption of 2022. Assets under management (also known as AUM) fell dramatically as a result of declining markets and net outflows, which reduced income. In addition, inflation increased costs. Asset managers also kept making investments and improving their skills in fields including private markets, ESG integration, and digitization. The predictable result was substantial pressure on average revenue margins. The Forty leading asset managers in the world had an overall loss in AUM of around 15%, a decrease in revenue around 24%, and an operating margin decrease of 14% points during the fourth quarter of 2021 and the third quarter of 2022.
These pressures are unlikely to decrease in the coming year. Recent investment presumptions have been proven wrong, and even if the current economic challenges partially reduce, the changing market environment will have a significant impact on asset management:
In other words, investor expectations will rise in complexity, expense, and demand. This will place a tremendous amount of strain on the financial well-being of businesses, along with reduced AUM growth and increased company competitiveness.
Questions And Answers
What are the predictions for the growth of the world economy?
The year 2022 was shocking. The growth results for 2022 were far more stable than the historically volatile years of 2020 and 2021, which saw the biggest global recession on record accompanied by the strongest recovery. The global economy has been rocked by numerous negative shocks this year, ranging from supply and demand concerns affecting the labor market, a third large COVID-19 wave, to Russia's invasion of Ukraine.
As 2023 approaches, the drag of tighter monetary policy is intensifying, yet central banks continue to advance. 25 of the 30 nations Doorway Financial Research monitors have increased their rates. No doubt, there will be more.
According to current projections, the Federal Reserve (also known as the Fed) will have raised rates by a total of about 450 basis points (bp) by the first half of 2023. The Fed is anticipated to suspend rate hikes by the conclusion of the first half of 2023, followed by other significant central banks. This central bank activity is casting some doubt on the forecast for next year.
The rapid increase in borrowing costs has already had a negative impact on housing activity, and it is expected to have a negative impact on the profit margins of American corporations. Additionally, there are more and more indications that general credit conditions are tightening. The tremors coming from low-income commodity importers in emerging markets (EM), U.K. pension funds, and the U.S. crypto market are not unrelated; they indicate that quickly tightening financial conditions are creating stress that may have negative spillover effects that could endanger macroeconomic stability.
"Despite the fact that the winter is expected to make China's COVID issues and Europe's natural gas situation worse, we do not believe that the world economy will soon be in danger of entering a recession in the first quarter of 2023. A fading of supply chain and volatility in commodity prices is cushioning the financial conditions drag, according to Gary Alan, Chief of Economic and Policy Research at Doorway Financial. After reaching over 9% in the second quarter of 2022, global CPI (consumer price index) inflation is projected to decrease to 3.4% in the early months of 2023.
PRIVATE MARKETS: OPPORTUNITIES AMID DISRUPTIONS
We think that as the year goes on, market circumstances in 2023 will probably offer enticing entry points whether you're new to the private sector or an experienced investor. The following are the main areas where we anticipate future outperformance to be most likely:
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Private equity fundamentals: Opportunities are created by public market volatility
Based on indications of a slowing U.S. economy, we think now is a good moment to invest in fundamental private equity. Since asset valuations frequently lag behind public markets, prices for huge, market-dominating private enterprises are becoming more accessible to managers looking to invest their capital. The recent decline in the overall amount of initial public offerings (IPOs) worldwide presents opportunities for managers as well.
Businesses that are unable to obtain financing from the IPO market may be compelled to remain private for a longer period of time, which is excellent news for the private equity managers who have plenty of capital to offer. As such, many anticipate that deal flow will improve this year.
In the future, managers who have demonstrated success during slow-to-no growth times may be well-positioned to thrive in a difficult economy. Private equity managers who interact with their portfolio firms as owner-operators, reducing expenses and using their understanding of the capital markets, are far more likely to be more successful than their counterparts. - Secondary: The market saw the emergence of reputable institutional funds We expect possibilities in the secondary market for private equity investments as numerous institutional investors try to unload some of their present private stock holdings as a result of having to restructure their portfolios to achieve target ratios. Discounted offers for portions of existing, high-quality funds are frequently the result of this dynamic, which develops when reduced public equity prices cause institutions to overweight private equity. A few clear benefits of investing in secondary markets include:
- Obtaining access to a mature fund portfolio can help investors because it offers a wide variety of investments and is more likely to result in a capital return.
- The fundamental asset portfolio of a fund's secondary securities can also be seen clearly.
- As with any private market opportunities, but particularly with secondaries, choosing an experienced manager with a solid network of institutional connections and an established track record of spotting assets of exceptional quality with considerable potential for upside is crucial.
- Growth equities and venture funding: Young businesses seek greater assistance Growth equity, which invests mostly in mid- to late-stage tech startups, gives investors access to market segments including cybersecurity, climate technology, and artificial intelligence (AI), which can be challenging to access through public markets. Growth equity is however vulnerable to market fluctuation—and 2022 was no different—as is the case with all tech investments. Growth equity experienced the most drop in asset prices over the course of the previous year of any industry sector. As long as capital is scarce, which it is this year, valuations are expected to decline as a result.
- In the growth equity and venture space, there is a significant difference in performance between top and bottom-performing managers. We think managers who have extensive industry connections, have invested during difficult growth investment times, and have strong business understanding will perform better.
- Infrastructure: Entry points are created by global movements As the world works to speed up digital enablement, lessen reliance on fossil fuels, and deglobalize supply chains, structural developments are reshaping the competitive landscape across all global infrastructure markets. The demand for new, alternative digital, environmental, or industrial infrastructure is projected to grow as these transformations proceed. The need for additional funding is still present for many traditional infrastructure assets, such as utility or power firms. We observe a significant mismatch between infrastructure spending and the estimated $3 trillion global need for new capital. For skilled managers with particular operating experience, this gap presents an opportunity. Working with seasoned managers who can handle the complexity of different infrastructure types and guarantee proper diversification is crucial for investors who are new to this asset class.
- Private credit: Suppliers have more control over pricing More businesses are shifting to private credit as public markets and banks, which are both common forms of credit funding, become less accessible. Demand for private finance alternatives has already started to rise as a result of increased uncertainties and decreased issuance of bonds in public markets. For instance, between 2021 and 2022, the issuance of high yield bonds decreased by 75% year over year, while that of leveraged loans decreased by over 65%. Banks are currently dealing with liquidity problems that haven't been seen since the financial crisis of 2008. When the economy and markets are under pressure, private credit managers possessing available money may request more favorable conditions (which includes higher premium) on the loans they offer. In the case of a sell-off in bonds with high yields and leveraged loans, those having underwriting and public market experience are prepared to take action. We anticipate greater difficulties with credit or "special situation" opportunities to arise even if rates stay the same. These changes might aid in differentiating outcomes for credit funds that start in 2023.
Growth equity experienced the biggest drop in asset prices last year of any industry sector. Since money is still in short supply and many companies are expected to require it this year, we predict valuations will decline. Managers of growth equities and venture funding are prepared to supply that required funding. Keep this in mind if you want to access creativity and expansion:
Can we expect the private markets surge to last?
The dealmaking environment dramatically decreased after the post-pandemic, record-breaking speed of 2021, and 2022 turned out to be a quiet year for initial public offers (IPOs) and M&A (merger and acquisition) activity. The general economy was burdened by geopolitical tensions, inflation, and interest rate increases, which caused market conditions to be unstable for businesses trying to go public. According to Dealogic data, there were more than of 500 traditional IPOs or outright listings in 2022 with a market cap of a minimum of $40 million, down from 1,270 in 2021.
While some household brands, like Porsche, who raised over $9 billion (over $8.9 billion) in its initial public offering in September 2022, continued to pursue a public listing, several companies instead opted to raise capital in the private sector. Currently, private market fundraising is outperforming IPO market volumes and attracting investors including private equity (PE) firms, venture capitalists (VCs), and sovereign wealth funds. The Doorway Financial Private Capital Markets team explores the major trends influencing activity and the view for 2023 in this article.
Who Makes Investments in the Private Markets?
Looking back at the previous year, I can see that the volumes remained largely steady. A lot of capital was used in 2022, according to Jeremy Richards, the Global Chief of Private Capital Markets at Doorway Financial, who noted that more than $200 billion in funds was raised and more than 1,480 deals concluded, each of which was worth over $55 million. Investors continue to struggle with genuine uncertainty. Investors are searching for protection from downside in private market acquisitions more so than in prior years due to increased market volatility, squeezed public market valuations, and the risk of a U.S. recession.
According to Richards, "We're seeing investors look for cushion when making deals more and more, and that cushion comes in the way of a decrease in valuation or structure." In addition to requiring additional downside protection, the investment base in the private market has changed. In the past, VCs and PE growth funds have backed private marketplaces. Following, there was a lot of interest and funding from mutual funds, public market investors, and sizable, tech-focused hedge fund groups, but this demand has drastically decreased due to the stock market sell-off in 2022, especially in tech.
Which Private Market Sectors are Anticipated to Experience the Highest Increase in 2023?
Is this trend expected to continue in 2023 given that technology companies have played a significant role in the expansion of private markets over the past ten years? After a ten-year bull run in tech stocks unexpectedly came to an end last year, the sector is now in the spotlight, which could delay the IPO of emerging tech startups. "I do think that we'll continue to witness more of the conventional tech brands entering the market for private placement this year," said Richards. These names include software, fintech, and even some consumer internet firms. This is mainly because these companies are waiting in line for IPOs and require funding. They will require capital, and they will need to obtain that capital from the private capital market, if they are to demonstrate the potential for expansion and profitability required to be acceptable IPO candidates.
Investor interest is rising significantly outside of the tech industry in areas like renewable energy and energy transition. In 2022, Doorway Financial supervised almost a handful private energy transitions and renewable transactions, and no fewer than another dozen transactions are scheduled to close in 2023. Energy transformation has been a major area of concern for us. In particular, corporate VCs and specialty funds are increasing their investments in the energy transition, renewable energy, and climate area, according to Hogan. "People are aware that this is a challenge which has to be tackled and that doing so will need significant financial resources. There is money available for businesses exhibiting solutions in their specialized area of this industry. These businesses are not exempted from the problems other industries are having, as valuations are still being squeezed, and they are not yet obvious IPO names. Due to the fact that a great deal of these startups is attempting to solve extremely difficult global challenges and consequently have substantial funding needs, the buyer community and issuers tend to be more inclined to converge on valuations.
“Energy transformation has been a major area of concern for us. There are numerous new funds coming from established investors that are primarily aimed at the renewable energy, climate, and energy transition sectors. People are aware that this is a challenge which has to be fixed and that doing so will need significant financial resources.” Doorway Financials’ Bill Hogan, Chief of EMEA Private Capital Markets.
Do Investors Need to Worry?
Although the 2023 Market Outlook notes a number of positive trends for the asset class as a whole, it also recognizes the difficult macroeconomic climate and its effects on private markets. Doorway Financial has not observed capital raising maintaining pace with deployment over the past four years, despite 2021 being an exceptional year for fundraising. 2022 will be significantly lower than 2021 levels.
A number of factors contribute to this, including the denominator impact, the numerator effect, as well as what the paper refers to as "the fear effect," whereby declining public markets nearly always result in some investor withdrawal in illiquid investments.
Additionally, the Market Assessment draws attention to a number of concerning signs, particularly in the buyout and real estate sectors, and advises investors to move forward with extreme caution. The analysis suggests that investors should exercise restraint through 2023 and beyond, even though there are still compelling transactions to be made and reputable general partners raising money now.
In conclusion, Doorway Financial anticipates that volatility will continue throughout 2023 as investors deal with inflation, changes in interest rates, and continued geopolitical conflicts. The 2023 Market Assessment reveals that, despite the difficult investment environment, the private sectors have continued to offer investors the appealing returns they want, with clear areas of potential in the year to come.