Real Assets Fundraising: Hurdles and Possibilities
Throughout the first half of the second quarter, it appeared that inflation would continue to fall, albeit slowly, but unanticipated price rises, primarily due to increasing energy costs in the latter part of the quarter, have muddied the picture as we begin the fourth quarter of 2023.
While banks look to be more solid today in the aftermath of the March massacre, the market must also struggle with a slowing economy and a bevy of other major issues weighing on investors.
The Fed has repeatedly telegraphed that it will do what it takes to rein inflation and keep policy tight until it returns to their 2% target. As the saying goes, “don’t fight the Fed.” Interest rates are likely to remain higher for longer for “some time,” said Fed Vice Chair for Supervision Michael Barr at a conference in New York in prepared remarks on Monday.
The higher-for-longer environment may bring both hurdles and possibilities across the private markets fundraising landscape, which has not been able to adjust equity values for the new higher-rate environment.
According to Michael Underhill, co-founder, CIO, CEO, and ADISA president, there are numerous factors influencing fundraisers, including inflation, the denominator effect, fewer GPs attracting a larger share of capital allocations, and the democratization of private markets.
He expects LPs to expand their allocations to private debt and infrastructure. Over the next year, nearly half of LPs intend to boost their target allocations to both sectors.
Since the Global Financial Crisis, when record low interest rates encouraged investors to seek greater yields in private markets, private debt has gained in popularity. During the pandemic, the low-rate environment kept the trend going, but floating rates have recently provided some inflation protection, adding to its allure, added Underhill.
Traditional lending providers (banks and insurance firms) are reducing risk on their balance sheets by reducing loan writing. The onslaught of maturities due in the future will necessitate refinancing, and private lenders are well positioned to capitalize on the opportunity.
Over the last four years, fundraising for energy transition infrastructure has skyrocketed. Capital is coming from managers who are launching new sector-focused strategies, as well as others who are committing a portion of their overall plans to clean energy themes, according to consulting firm Verus Investments.
From 2018 to 2022, $65 billion was raised for sustainable infrastructure compared with the prior eight‐year period (2008‐2017) that raised $6.5 billion, noted Verus.
According to Underhill, infrastructure has “burnished its appeal” as some countries seek to generate greener energy in the aftermath of the Ukraine crisis, shifting global supply chains, and the post-pandemic shift toward digital commerce. President Joe Biden’s vast infrastructure development plan, he continued, is also likely to help provide attractive investment possibilities.
Nearly 42% of investors plan to increase their target allocation, compared with 33% six months earlier. Only 5% plan to reduce their allocation, while 11% intend to trim their allocations to private debt, noted Underhill.
Noncore infrastructure is probably more vulnerable to increased capital costs due to exposure to floating rate, noninvestment grade loans. But this can be partially mitigated by stronger cashflow growth and management teams’ ability to add value.
Verus has witnessed a “blurring of lines between infrastructure and traditional private equity buyouts” as new businesses based on rising themes are added to the fold, including energy transition, healthcare, trash and digital infrastructure.
As for the US real estate market, although assets under management crossed the $1 trillion threshold as of 2022, the asset class has felt growing inflationary pressures, investor risk-aversion and the ramifications of rising interest rates.
Rising interest rates are causing stress and distress across the real estate spectrum, as the cost of borrowing and loan-to-values rise, and lenders withdraw from the market. Borrowers will be forced to remain creative with financing as they often lack fresh equity capital and want to minimize their dilution.
Fundraising fell from the record-breaking $63.2 billion achieved in the fourth quarter of 2021 to $26.3 billion at the end of 2022, according to Underhill. Aggregate deal value and number largely stabilized, with opportunistic and value-add strategies occupying most of the funding.
Underhill left us with his ongoing concerns, or VUCA (Volatility, Uncertainty, Complexity, Ambiguity), and cited the following reasons: “Stocks are falling like a recession is coming; oil prices are rising like there’s no recession in sight; interest rates are rising like we have 10% inflation; gold is falling like inflation is gone; housing prices are rising like rates are falling; and commercial real estate is falling like its 2008.”
“Nothing adds up here,” he concluded.
