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Global Perspectives
Private Capital - Heading Into 2024
As we approach 2024, the private capital industry stands at a critical juncture, shaped by a confluence of global economic shifts, monetary policy changes, and evolving market dynamics.
Reflecting on Warren Buffet's adage about the revealing nature of a receding tide, the sector now faces a reality check after a prolonged period of cheap debt and high returns.
Our latest Global Perspectives piece delves into the current state of the private capital industry and its prospects as we look towards 2024.
Economic Context and Market Dynamics
The landscape of 2022, characterised by a rapid increase in interest rates in response to surging inflation, set the stage for the current scenario. Central banks, notably the US Federal Reserve, have made significant policy shifts, moving away from near-zero interest rates to a more hawkish stance, marking the fastest rate hikes in modern history to a level that hasn't been seen in 22 years. These changes have profoundly impacted market volatility and asset valuations, leading to a sell-buy side gap.
Globally, the economic growth projections for 2024 remain cautious. Advanced economies are bracing for modest growth while emerging markets show more resilience. The long-term impacts of COVID-19, especially in China, continue to influence global trade and economic stability, alongside the persistent geopolitical tensions stemming from the Russia-Ukraine and Middle East conflicts.
Private Capital Industry Outlook
Against this backdrop, the private capital industry has had to navigate many challenges. Market performance across tangible assets, stocks, and bonds has been mixed, with many assets undergoing significant repricing.
Private equity has witnessed a transformation, challenged by high-interest rates and inflation. LPs have seen a liquidity crunch as portfolio company holding periods mature beyond the usual five-year investment horizon in a moribund exit market. With too few exits, the standard cash recycling model has slowed, leading to asset allocation limits being tested and a shortage of new liquidity available to meet fundraising targets.
The brake on returns applied by the testing macroeconomic environment has seen firms increasingly rely on sophisticated tools like continuation funds (see our recent deep dive), NAV loans and deferred consideration solutions to manage market timing and liquidity issues, safeguarding high-value assets from untimely disposals. Another innovation in an area traditionally regarded as a succession planning tool has emerged by way of LP interest in GP stakes.
These tools have evolved from resilience and recovery mechanisms to a strategic portfolio management approach, enabling companies to realise their full potential.
Investment trends within the industry are also shifting. There's a growing focus on sectors like AI, energy transition, food security, med-tech and infrastructure, and supply chain diversification, reflecting a broader trend towards more sustainable and resilient economic models. Data centres, energy and private credit are also in favour with contrarian investors. The tightening of bank financing has opened new opportunities for private credit. With first-lien security and equity-type returns, there is a strong incentive to fill the gaps left by traditional lenders.
Investor Sentiment and Expectations
Investor expectations are adjusting to the new normal. The stellar returns of previous years are giving way to more tempered forecasts. However, this recalibration is positive. Investors are becoming more discerning, seeking opportunities that offer sustainable financial returns and align with broader economic and social goals.
Regulatory and Policy Developments
Regulation, particularly in the United States, has become more interventionist, focusing on Private Equity deals. In July, the FTC proposed changes that would automatically trigger regulatory scrutiny of PE involvement in transactions valued above US$111.4m.
Again, in the US, CFIUS has been clearing fewer deals.
In the UK, the National Sensitive Investment (NSI) Act has been widened to include 17 categories of sensitive investment subject to government scrutiny.
In Europe, 18 of the 27 EU nations now have substantive FDI screening requirements, and new measures to address sustainability have been introduced through the Sustainable Finance Disclosure Regulation (SFDR).
Central banks' policies, particularly around interest rates and monetary measures, are critical in influencing the private capital industry. Any shifts in these policies as economies stabilise or face new challenges will directly impact investment strategies.
The regulatory and policy changes highlighted above could redefine the operating landscape for private capital firms, emphasising the need for agility and foresight in investment decisions and requiring a re-appraisal of geographical and sector allocations.
Risk Assessment and Future Projections
The risk of recessions in major economies like the US and Europe is a looming concern. Whilst many favour the soft-landing scenario, the industry must prepare for potential downturns, ranging from short and shallow to prolonged and deep.
Looking ahead the private capital industry appears poised to adapt and evolve. The possible end of the rate-tightening cycle offers some hope for stabilisation and recovery.
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In conclusion, as we edge closer to 2024, the private capital industry is navigating a complex and rapidly evolving landscape. While challenges abound, from economic uncertainties to shifting investor expectations, the industry's adaptability and innovative approach position it to weather the current storm.
The focus on sustainable investment trends and the strategic use of portfolio management tools signals a resilient and forward-looking industry ready to embrace the opportunities and challenges of the coming year.
About our Blog
Global Perspectives provides regular, on-point commentary on relevant topics in a pithy and accessible way. Our observations and points of view are based on listening hard to clients global needs, priorities and concerns. We draw on insights from every area of our business and collaborate to deliver this global thinking; something that clients tell us is distinctive and sets us apart. If you'd like to find out more, please get in touch.
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About Mourant
Mourant is a law firm-led, professional services business with over 60 years' experience in the financial services sector. We advise on the laws of the British Virgin Islands, the Cayman Islands, Guernsey, Jersey and Luxembourg and provide specialist entity management, governance, regulatory and consulting services.
