Oct 05, 2020
Article posted by Abby Schultz on www.barrons.com

Investing in private markets continues to be a popular strategy for wealthy investors and institutions, and one that has proven to be resilient even during the first quarter of this year as the coronavirus pandemic began to grip the globe. 

As of the end of last year, assets in private market funds globally hit US$6.5 trillion, a 170% increase over the previous 10 years, and a 10% increase for 2019 alone, according to a February report by McKinsey & Co., a U.S. consulting firm. By comparison, assets in global public markets rose about 100% in that period. 

In the first three months of this year, private market funds experienced losses, but not as much as the public markets, continuing a pattern of outperformance, according to UBS Global Wealth Management’s chief investment office. 

Private-equity fund returns, for instance, fell 10% in the first quarter compared with a 30% decline in the Russell 2000, a small-cap stock index, while private-debt fund returns fell 5%, compared with a 13% drop in the S&P/LSTA Leveraged Loan Index, which tracks the performance of the largest institutional leveraged loans, UBS said in a report published earlier this summer.

One issue for private markets funds has been an influx of capital from investors that in turn needs to be invested. In the initial months of the pandemic, investing that capital proved difficult in part because businesses were struggling, and in part because funds were unable to access financing. 

But both those factors are changing, according to Jake Elmhirst , head of private markets, and Jay Won Lee , a private markets strategist, both at UBS Global Wealth Management. 

Betting on Technology and Healthcare 
“From an investing perspective, we’ve seen activity levels pick up,” Elmhirst says. After a quiet period, where investment activity ground to halt, investment pipelines are filling up. 

The funds that are able to put money to work largely are investing in sectors that have been resilient through the Covid-19 crisis or have benefited from it, including private companies involved in technology and healthcare. More traditional companies involved in consumer businesses, travel, and commodity-based businesses, however, continue to struggle.

“There’s definitely a bit of a sense of have and have-nots by sector,” Elmhirst says. 

Technology companies—particularly software companies—have been especially resilient in the past few months, Lee says, and, as a result, fund managers are keen to buy them.

“Looking out 10 years, there are a lot of trends Covid has perhaps accelerated,” he says. “We think investing in the digitization trend, and e-commerce, will remain attractive looking into the next decade.”

One reason investment activity is stepping up is funds have greater access to financing now than they did in the first quarter, Lee says. At the beginning of the year, lenders were more selective, asking for higher equity contributions for underwriting new transactions, according to UBS’s report. 

When to Invest in Private Markets
Funds that form in “crisis years”—as 2020 can be defined—historically earn the highest returns, according to the UBS report. Funds that formed in the year after a market peak, for instance, reported internal rates of return (IRR) of 18.6% compared to a return of 9.7% for the MSCI All Country World Index (ACWI) public market equivalent, according to a UBS analysis of funds formed between 1994 and 2017. 

One year before a market peak, this same set of private funds reported an IRR of 11.4% compared with 5.4% for the MSCI ACWI, UBS said. 

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