What is private capital?
Research house Preqin defines private capital to include private equity, private debt, infrastructure, private real estate and natural resources, and usefully breaks each of these down further to give a sense of the investment opportunity set available within private capital.
Analysis of Closed-End Private Capital
Drivers of the private capital markets
Private capital assets under management increased from $0.7 trillion to $4.9 trillion between 2000 and 2017 (source: Preqin) representing a CAGR of 12.5% pa. This growth reflects a number of drivers:
- Increased demand from investors. Investors, such as pension funds, sovereign wealth funds, endowments and high net worth individuals, have increasingly turned to private capital as they seek to diversify portfolios, reduce risk and enhance returns. Pension funds, faced with large and growing deficits, see private capital as a source of alpha (above-market returns) as well as offering a broad range of yielding investments to enable them to meet their liabilities. Sovereign wealth funds have turned to private capital to help address shortfalls and volatility caused by energy sector price swings. Investors allocating to private capital markets like the investment models and believe in the ability of private capital to outperform public markets on a sustainable basis.
- Outlook for returns in public markets. Market commentators are holding out the prospect of a sustained low-return environment in public markets over the next 20 years, both for equities and fixed income. This follows the low-yield environment that has persisted since the economic crisis of 2007-08, as governments have implemented expansionary monetary policies.
- Public markets have become less attractive to smaller private businesses. Recent years have seen a trend of falling numbers of listed companies and growth in the number of private businesses. M&A activity, corporate failures and take-private transactions have reduced the number of listed businesses. Smaller private companies are increasingly choosing to stay private in order to avoid the regulatory and other burdens of being a listed company and because of the higher availability of private funding . In addition, public credit markets have over recent years become less receptive to smaller and more lowly-rated issues.
- Reduction in bank lending to corporates combined with increased demand from corporates. Historically, banks have been the primary source of debt finance for European companies, whereas, in the US, this funding has been predominantly institutional. Post the economic crisis, bank lending to corporates has reduced significantly, particularly in Europe, in response to regulatory and balance sheet pressures on banks. Banks have both reduced their activity in the new corporate loans market and have also made substantial dispositions of loan assets to market participants. At the same time, SMEs have sought fresh loan funding to refinance existing loans and fund business growth strategies.
- Increased role for private funding in public infrastructure projects. Over the last 20 years, governments have increasingly resorted to private sector funding of infrastructure spending in the face of constrained budgets. According to a study by McKinsey (2016), the world needs to invest $49 trillion globally by 2030 in building and maintaining core infrastructure (transportation, power, water, and telecommunications). This large deficit is the result of decades of insufficient spending, primarily by governments, which have not invested to meet the needs of growing and increasingly urbanized populations.
- Growth of multi-asset managers within private capital. Since 2000 a number of private equity fund managers have broadened their product offering to include a range of private capital strategies. This was partly in response to demands from LP investors, keen to invest with fund managers they trusted and to reduce the costs and risks involved in managing multiple fund manager relationships. Some larger LP investors also favoured using multi-asset fund managers because this enabled them to deploy large amounts of capital with one party, using their scale investment to negotiate reduced fee rates and other special terms. Fund managers responded enthusiastically to these demands, since it allowed them to improve their own diversification and increase their ability to manage larger amounts of capital.