LPs have plenty of food for thought in the early months of 2023, as we discover in this month’s cover story in which we interviewed leading investors from around the world. Asked about their allocation priorities, four possible directions of travel emerged:
1. Away from safe, lower-return private debt: If your target is an 8-10 percent yield from private credit, it’s exciting when interest rates are low. But what happens when you can suddenly get high yield on a similar basis? That’s why Reji Vettasseri of Decalia argues that investors may need to be a little adventurous and target more opportunistic strategies offering higher returns in exchange for a bit more risk.
“You can’t rely on just doing the same deal you did last year at the same price,” he says. “If you are still targeting a 7 percent return and you haven’t increased the return that you have historically got, you will undoubtedly see more pressure from investors. Yet, for the best strategies, there is real potential to not only increase pricing in line with public market yields but also to add an increased premium through more opportunistic deal-making.”
2. Towards capital solutions: “The path we’ve taken is not having a whole lot of corporate credit sensitivity with rates so low and spreads so tight. We may change that a little bit in the coming year depending on how markets move,” says Eric Farls of the Maryland State Retirement and Pension System.
One possibility, says Farls, is adding direct lending to the portfolio. Another is to back stressed or distressed-type managers. “We have some exposure to managers with fairly flexible mandates but we haven’t pushed too hard into those areas over the last few years.”
3. Away from private markets towards listed equities: This may seem counterintuitive, but sources say some investors point to an inability to time deals in private markets due to their long-term hold nature – and therefore the relative attraction of public markets in times of stress.
Some investors “would rather do listed equities if the markets are very dislocated because they believe, rightly or wrongly, that they are great at timing the markets”, says Ari Jauho of Certior Capital. “If an investor thinks it can buy from the bottom when equities are cheap and make 20 percent annual returns, it’s very difficult to do something similar in the short term with private assets, whether private equity, private credit or real estate.”
4. Towards venture debt: Asked which strategy looks best placed in the early months of 2023, some investors cite venture debt. As rates go up, the strategy is seeing higher coupons, warrant coverage going up, higher pre-penalties and a growing constituency of borrowers in need, they say.
With venture companies tending to stay in the private domain for longer, they need the capital to also stretch for longer but have no desire to give up equity. Instead, they are turning to loans with durations of two to three years. “It’s a small market but represents a really good opportunity,” says Andrew Eberhart of Wingspan Capital.
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