Central bank base rates and funding levels were the key unspoken agenda items at this year’s Private Markets Forum organised by Room151 at the London Stock Exchange.
Aoifinn Devitt, chair of the event
While rates have remained higher than many investors had priced in at the beginning of the year, private markets have overall appeared relatively resilient to higher borrowing costs so far. But at the front of everyone’s mind was whether this benign environment might be due to change.
And while most LGPS funds are currently fully funded, investors were acutely aware that these favourable circumstances could soon change, if rates were to come down.
Consequently, across the debates, investors approached the sub-asset classes with a growing sense of caution, whilst acknowledging that the need to generate returns was perhaps higher than current funding levels might suggest.
Secondaries
In this changing environment, secondaries have become an asset class which is attracting growing investor interest. There are “attractive risk-reward, whatever the cycle” opportunities in the secondary market, according to David Atterbury, managing director at HarbourVest,. Achal Gandhi, CIO – indirect real estate strategies, chair of the global DE&I council at CBRE Investment Management, and Vanessa Shia, head of private markets at London CIV, also offered their assessments.
Atterbury noted a “step-change” in the secondaries market in recent years, with well over £100bn worth of transactions being closed in 2023. This has been driven by the stock of private equity assets available, and the need for liquidity across the market today.
He said there had been a propensity to sell across the entire LP universe, with there also being an acceleration in GP-led secondaries.
On the demand side, the secondaries marketplace was “pretty tight”, with the level of dry powder being relatively benign in terms of competitive dynamics, leading to significant discounts, he argued.
“People are increasingly recognising the risk-reward benefits [of secondaries],” Atterbury concluded, with there being access to mature assets and the opportunity for “real outsize returns”. “There is a time for a bargain given the buy-sell dynamics in the marketplace,” he said.
Gandhi focused on the real estate secondaries market, which he described as “not as longstanding as private equity but very fast catching up”. He noted attractive opportunities, but said it was important to have a real estate strategy first, and then “execute via secondaries”.
There is a “significant” capital markets dislocation, but in a “story of two halves” there is no occupier market dislocation, as rental growth continues to be positive. All in all, the conditions are right to acquire real estate secondaries at a “trough point” in the market.
Shia explained why secondaries should be a key part of an LGPS portfolio, having helped to address some of the challenges investors have faced. “The key benefit is immediate deployment and you can see the return quicker,” she said.
She also noted that better quality assets had come to the market as LPs had rebalanced their portfolios, with this being the key difference today compared to a few years ago.
Private equity
One of the asset classes which felt the sting of higher rates the hardest was private equity. But despite these short-term headwinds, Andrew Carnwath, director and head of impact, private equity at Columbia Threadneedle, argued that there was still plenty of untapped opportunity in unlisted markets, with over 90% of all business with more than $100m of revenue globally being unlisted.
At the same time, he acknowledged that “the era of debt-fuelled M&A deals is definitely over”. He stressed that this offered a new set of opportunities such as impact investing strategies. “If you are making money by making the world a better place people will help you, if you are making money by plundering the world, at some point people will stop you,” he warned.
Lawrence Rusoff, managing director at Performance Equity, outlined the areas where LPs could benefit from investing through a fund of fund structure. This approach could be particularly beneficial to relatively smaller investors seeking exposure to areas like venture capital and middle market buyout strategies which traded at significant discounts, and where they could benefit from the research capacities of an external manager.
Neil Mason, assistant director and LGPS senior officer at the Surrey Pension Fund, opened up the debate by expressing scepticism of current funding levels for his £5.2bn fund, which according to the latest estimates is more than 130% funded. But Mason argued that there was still a case to be made for investing in private markets. The fund, which is part of the Border to Coast pool, currently holds around 20% of its portfolio in private markets.
This also resonated with Stephen Wild, head of pensions & treasury at the London Borough of Newham, who revealed that his £1.7bn fund had recently doubled its allocation to private equities to 10% of the overall portfolio, based on the advice of its consultants. Having said that, he admitted that the outlook for the asset class was becoming more challenging and stressed that he kept a close eye on the portfolio.
Policy and governance risks in private markets remained a concern, with water and rail companies in particular making negative headlines, Mason said, but he also expressed confidence that the pool was able to avoid these underperforming companies. “This country has a long history of privatising profits and socialising debts; I look to our colleagues at Border to Coast to ensure we are with the right managers,” he stressed.
Natural capital opportunities
Andy Turnbull, senior investment manager for the UK Nature Impact Fund at Federated Hermes, kicked off the debate on natural capital by sharing his background as a chartered rural surveyor, having developed nature based carbon projects in South East Asia and Latin America and having lived in the Amazon Rainforest.
Focusing on the return drivers behind the growing demand for natural capital, he explained how the global drive towards net zero and nature restoration was creating investment opportunities. “All net zero pathways require a massive increase in investment into nature restoration. Restoring nature and natural habitats can provide one third of all the carbon removal and reduction measures required to achieve net zero,” he said.
Predicting a supply-demand imbalance as companies accelerate their net zero efforts, he stressed that the UK offered particularly strong opportunities. “The UK has some of the highest integrity nature markets in the world,” he argued. Compared to global markets, UK carbon credits currently trade at a premium and offer relatively lower volatility, he added.
Stephen Levesque, managing director of forest operations at Campbell Global, which is part of J.P. Morgan Asset Management, followed up. Like Turnbull, his career started off with a passion for nature, having worked initially as a wildlife biologist with a degree in forest engineering and biology.
Campbell Global has been investing in forestry and natural capital for more than 40 years and Levesque outlined that the recent rise in inflation had been an opportunity for the firm, with natural capital offering an efficient inflation hedge.
“We do see that there is going to be price appreciation in some markets, the bulk of capital appreciation is driven by forest growth. Think about tending to a massive garden, when you put in the right tree in the right location at the right time of the year, spaced correctly, it enables us to grow those older more valuable logs which will eventually be turned into paper and cardboard Amazon boxes or panels and beams,” he stated.
Levesque said that this message was particularly well received by European investors: “Trees are the best technology we have for storing carbon; we need to harness that power, photosynthesis is elegant,” he stressed.
Adding in the LGPS perspective, John Raisin, independent advisor and independent chair of the pension board at Merseyside, expressed surprise that it has taken natural capital so long to gain popularity. He was confident that improved funding levels, a focus on cash flows and regulatory pressures meant its time had now come. Raisin said that pooling had also acted as an accelerator for growing demand for the asset class.
Housing
Wrapping up the day, delegates turned their attention to one of the most widely covered alternatives sector, housing, and in particular the dire need to fund the UK’s housing stock.
Adrian D’Enrico, fund manager, funding affordable homes at Edmond de Rothschild Asset Management, started the discussion by stressing the scale of the crisis, with more than 140,000 children in the UK currently being homeless.
D’Endrico made the case that affordable housing as an income generating asset with inflation linkage offered an ideal match for the LGPS.
This was backed up by Shamez Alibhai, head of community housing and managing director at Man Group, who emphasised the structural nature of the UK’s housing crisis. “We think the shortfall in rented products will continue, the supply side for housing stock continues to fall,” he predicted.
He highlighted that England had some of the highest homelessness rates among developed market economies and also the oldest housing stock.
Paddy Dowdall, assistant executive director at Greater Manchester Pension Fund, explained that for local authorities, it was not lucrative to execute the development themselves. “As a local authority, we are dealing with some structural problems. If we build them in our own name, people will be entitled to buy them for not very much money and that doesn’t work well for our IRR calculation,” he explained.
“Over the past five years, I have seen more investable opportunities for affordable housing with a capital A, but I am not sure that is great for the country. We’re not here to beat the lowest cost of capital, we are here to make more money than gilts,” he added. Whilst housing was not the highest returning asset classes, it offered attractive risk adjusted returns, Dowdall emphasised.
Liz Carey, independent advisor to the LGPS, added that while the housing crisis was not a UK specific problem, the US market had comparatively benefited from tax incentives which had brought down the cost of capital. For the UK, there were lessons to be learnt, she argued. “How do you bring down the cost of capital so that people who are otherwise shut out out of a commercial market can access housing?” she challenged the audience.
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