• Alternative Investments

A “Potpourri” of Market Rallies, Robust Direct Lending, Tech Sector Excitement

calendar_today August 29, 2022

Perhaps the most recognizable element of the popular game show Jeopardy! is its legendary theme song. And along with that famous jingle, “Daily Doubles” and Alex Trebek, Jeopardy! uses quirky play-on-words to describe the categories on the game board. Occasionally, when the writers have a series of questions that don’t have a common theme, they label that category “Potpourri.”

(Admit it … as you read this, you’re humming the theme song in your head, aren’t you?)

The last month could be described as a “potpourri” in the Jeopardy! sense. There was no shortage of topics to cover, but as we dive into this month’s update, there are a few topics worth expanding on.

After a big month for risk assets in July, the Consumer Price Index (CPI) began to tick down slightly—to 8.5%—which prompted another rally in the markets. The NASDAQ ended its bear market run on the heels of the rally early in the month. With food prices remaining elevated, the drop in energy costs garnered the biggest headlines throughout the month.

There has been some welcome relief at the pump recently. The national average for gas prices fell under $4 per gallon for the first time since March. In the hope of inflation having peaked, markets initially rallied in anticipation of a potential slowdown in rate increases. As inflation remains at multi-decade highs, the Federal Reserve Bank’s response will be first and foremost on investors’ minds, as the degree of the next rate hike is contemplated. And from a global perspective, many challenges remain.

What does this mean for the alternative investment markets?

In short, private credit continues to perform, especially direct lending strategies. With floating rates and short durations, direct lending strategies are not exposed to interest rate risk typically associated with other credit strategies. Since the public markets are currently unavailable to many corporate borrowers, the pipeline for direct lending has been robust and deal flow remains strong.

Through all this, investors remain cautious. As shown on Chart 1, Preqin’s recent institutional investor survey showed what the biggest challenges for private equity return generation over the next 12 months may be: exit environment, current asset valuations and rising rates.

One of the most popular questions we get from private wealth advisors relates to current valuations for private equity holdings. While most managers have been actively marking down positions to reflect the new environment, the predominant belief is the degree of the public market sell-off has been too extreme. In turn, the mark downs they are taking have been more measured compared to what has occurred in the public markets. Fund managers are hoping for more market stabilization soon, which may help to avoid additional dramatic write downs in the future.

Don’t expect a significant change in the markets until the Federal Reserve gives more direction around the degree of future rate hikes. In the interim—despite the dislocation—we remain excited about the technology sector and the disruptive potential of these companies. We continue to see a demand from investors for blue-chip private equity managers, especially from allocators with longer term investment horizons.

Many fund strategies have help to mitigate some of the market volatility we have experienced in 2022. The positive performance of hedge funds in July broke a string of multiple months of losses. During that streak, investors withdrew more than $30 billion of assets during the second quarter, pulling capital out of all risk strategies.

The last few months have focused on the denominator effect relative to flows being negative. Less-volatile positions can become outsized during times of significant market stress, forcing allocators to rebalance. This opens the door for hedge funds to act as ballast in a portfolio, especially as a substitute for traditional fixed income in a rising rate environment.

The second quarter was difficult for all risk assets. As the Federal Reserve continues fighting inflation with great fervor, we expect market disruption to continue. It’s worth reiterating that a long-term investment view is key and adding more risk mitigators through hedge funds and private equity can help clients navigate the continuing volatility. With this, we anticipate the investor appetite for alternative investment strategies across our advisor network to continue to grow.

 

PPB – August 2022 Market Blog

 

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The statements included in this material may constitute “forward-looking statements” and are subject to a number of significant risks and uncertainties. Some of these forward-looking statements can be identified by the use of forward-looking terminology such as “believes”, “expects”, “may”, “will”, “should”, “seeks”, “approximately”, “intends”, “plans”, “estimates”, or “anticipates”, or the negative thereof or other variations thereof or other variations thereon or comparable terminology. Due to these various risks and uncertainties, actual events or results of the actual performance of an investment may differ materially from those reflected or contemplated in such forward-looking statements and no assurances can be given with respect thereto.  Hedge Funds are Private entities and are not required to file with Preqin. The data given in this document is composed of all data that has been filed with Preqin but is not composed of every Hedge Fund.

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