The “golden era for secondaries” in private markets will carry on into 2024 while public markets continue to slowly recover after 2023, according to Hamilton Lane’s head of Southeast Asia, Kerrine Koh.
Koh refers to the recent trend in investors buying and selling a slice of private markets to rebalance their portfolio away from being public market dominant into private markets touted by its supporters as more resilient and offering better opportunities.
Following the “year of reckoning” of the global economy in 2022, the environment has only grown more difficult, says Koh. Although 2023 saw a slight recovery in public markets, only the Standards & Poors (S&P) “Magnificent Seven”, which refers to seven technology stocks, have dominated a large portion of the index.
“So many limited partners (LPs) still face pressure because if they didn’t hold the seven stocks, they were holding the 493, which were still down or flat,” says Koh.
For LPs to continue to invest in new vintages and deploy more funds, the private market became a way for investors to access more liquidity.
Hamilton Lane, which tracks more than 50,000 funds and 150,000 companies in private markets, notes that private markets have outperformed public markets over the past 22 years.
Assuming that investors invested at the same pace in both public and private markets over that duration, they would have observed that private markets demonstrated an outperformance on a y-o-y basis, which is even more pronounced during years when public markets are very negative.
The same is true in the private credit market, in which Hamilton Lane has found that in 21 out of 22 years, private credit has outperformed or performed at the equivalent of public credit.
“Many investors also invest in a secondary fund because distributions come back faster,” says Koh, who has over a decade of experience leading private markets at BlackRock, one of the world’s largest investment firms.
She explains that the draw of investing in a secondary fund allows investors to buy into the third or fourth year of the fund instead of investing in the first year, which can allow investors to see immediate returns. “That’s one of the nice characteristics of secondary funds,” says Koh.
Misconceptions about private markets’ risk
Historically, private markets had only been of interest to institutional investors. However, in the last five years, Hamilton Lane has observed more curiosity from individual investors.
While investors are increasingly finding private markets to be resilient, there remains a sentiment that this asset class is a “risky” one, says Koh.
“Many investors acquaint private equity with venture capital but they fail to take into account that the private markets have evolved over the past 20–30 years,” she adds. Today, 70% of private markets are buyouts, which refer to the acquisition of a controlling interest in a company.
These buyouts happen to mature companies with proper unit economics, with a recurring revenue stream, profitability and cash flow and not necessarily early-stage start-ups with no guarantee of growth and much less earnings.
As many of these mature companies have chosen to remain private, investors may find a lack of transparency in the valuation of said company. This could result in less confidence in accurately reported valuations than in public markets, Koh reasons.
However, the industry is fast evolving. Today, Hamilton Lane’s own fund that is available to individual investors includes a third-party validation every month.
Koh also highlights that the data on the performance of private markets shows that it has not been as risky as public equity.
“If you look at the worst five years in buyouts added together, in public markets it’s probably down 5% collectively,” she says. “In private equity, buyouts are probably 2.5% but the most important thing is that it is still positive. People don’t realise that that is as good as their CPF [returns].”
Markets bottoming out, reasonable valuations
Although there remain “a lot of headwinds”, there have been encouraging signs that markets are bottoming out and valuations are becoming more reasonable, says Koh. For this reason, investors may find it a good time to buy into companies.
In particular, Koh thinks this will be an interesting vintage for middle market companies, with less than US$5 billion ($6.65 billion) in enterprise value. “Because they are smaller, more nimble, serve a more local or domestic market and are less exposed to geopolitics, they tend to do better in an environment like this,” she says.
It will, therefore serve LPs to pay more attention and gain more exposure to the current vintage, she adds.
Koh also predicts that private credit will become important as private lenders rush to fill the gap that banks are leaving behind. As of 2023, Koh notes that the returns in private credit have grown more attractive than ever seen historically, at least in the last decade. She says that investors are not taking that much risk to get to that kind of return as well.
Finally, Koh believes that as the world moves towards the net zero by 2050 goal, investing in infrastructure funds will become a megatrend. Because most infrastructure projects in the world have an inflation link, in which developers have the right to increase the price of their output by a factor of inflation every year, this makes the asset class particularly resistant to inflation.
In a high-for-long inflation environment, investors who have not invested in infrastructure in the past are suddenly looking at the asset class, which will provide them a lockstep to inflation, says Koh.
