As market volatility pushes down valuations, now may be the time to think about investing
Few investors will look back on 2022 with affection. Russia invaded Ukraine, stock markets turned volatile, global supply chains broke and inflation soared. In an attempt to restore price stability, the U.S. Federal Reserve (the Fed) raised rates faster than it has since the 1980s.
In 2023, inflation may be starting to cool, but interest rates remain elevated, sparking liquidity problems in the banking industry. The risk of a recession still hangs in the air. These challenges are real, but we see fresh opportunities arising in private markets this year as volatility continues and valuations get more attractive. And for funds launching right now, we see the potential to realize strong relative returns over time.
History supports our view. Managers capable of providing capital when it is more costly and difficult for companies to obtain it have an opportunity to acquire assets at attractive prices and secure better deal terms. This dynamic has played out over several market cycles—managers that launch funds in periods of economic stress and market volatility tend to outperform.1
Even if the Fed does manage to engineer a soft landing for the U.S. economy in 2023, this year may prove a good year for many private markets. So if you want to access emerging opportunities in alternatives, now may be an ideal moment to do so.
Adding private markets to a portfolio
In the words of American polymath and founding father Benjamin Franklin, “out of adversity comes opportunity.” While it may be tempting to de-risk this year by holding more cash, opportunities will likely still emerge from ongoing market volatility. But where are they going to come from? And how can you think about adding them to your investment portfolio?
If you’re just starting to invest in private markets, it’s important to take a balanced and diversified approach—which includes diversifying by investment year, as well as strategy and asset class. Like fine wine, private investments are often referred to by their vintage years, which indicates the first year a fund starts investing in its three- to five-year lifecycle. Diversifying by vintage years can help achieve smoother, less volatile returns over time.
It’s equally important to diversify by manager, investment strategy, geography and asset type—just as you would in a portfolio of listed stocks and bonds.
If you already have an existing portfolio of alternative investments, you may want to consider adding targeted investment exposures based on your current holdings and long-term investment objectives.
Entry points emerge across strategies and assets
Whether you’re new to private markets or an experienced investor, we believe market conditions in 2023 will likely provide compelling entry points as the year progresses. Here are the key areas where we see the greatest potential for future outperformance:
- Core private equity: Public market volatility creates opportunity
We believe this is an opportune time to allocate to core private equity based on signs of a gradual slowdown in the U.S. economy. Asset valuations typically lag public markets, which means that prices for large, industry-leading private companies are becoming more reasonable for managers aiming to put money to work.
Managers also stand to benefit from the recent collapse in the total volume of initial public offerings (IPOs) globally.2 Companies that are unable to access the IPO market for financing may be forced to stay private for longer—and for private equity managers with ample funding to offer, this is good news. As a result, many expect to see increased deal flow this year.
Looking ahead, managers with good track records in periods of slow-to-no growth may be well positioned to prosper in a challenging economy. Private equity managers that engage with their portfolio companies as owner-operators, optimizing costs and applying capital market knowledge, are much more likely to outperform their peers by a wide margin.3
- Secondaries: High-quality institutional funds come to market
We see opportunities in the private equity secondaries market as many institutional investors—forced to rebalance their portfolios to meet target allocations—look to sell off a portion of their current private equity holdings. This dynamic, which arises when lower public equity prices leave institutions overweight private equity, often means discounted offerings for slices of high-quality existing funds.
Investing in secondaries can offer some distinct advantages: Investors can benefit by gaining access to a portfolio of mature funds that offers broad diversification and is closer to returning capital. Secondaries also can provide good visibility into a fund’s underlying portfolio of assets. As with all private market opportunities, but specifically with secondaries, selecting an experienced manager with a strong network of institutional contacts and a proven track record of identifying high-quality assets with significant upside potential is essential.
- Growth equity and venture capital: Young companies seek more support
Growth equity—which primarily invests in mid- to late-stage tech companies—offers access to industry sectors that can be hard to reach via public markets, such as artificial intelligence (AI), climate technology and cybersecurity. Like all tech investments, however, growth equity is subject to market volatility—and 2022 was no exception.
Last year, growth equity suffered the steepest decline in asset prices of any industry sector. We anticipate valuations will erode as capital remains scarce—and many companies will likely need it this year.
Growth equity and venture capital managers are ready to provide that needed capital. If you are interested in accessing innovation and growth, remember this: There’s a wide gulf between top- and bottom-performing managers in the growth equity and venture space. We believe managers with deep industry knowledge and networks, and experience investing through challenging periods for growth investing will be more likely to outperform.
- Infrastructure: Global shifts create entry points
Across global infrastructure markets, structural changes are redrawing the competitive landscape as the world seeks to accelerate digital enablement, reduce dependence on fossil fuels and deglobalize supply chains. As these transitions progress, the need for new, non-traditional digital, environmental or industrial infrastructure will likely increase. At the same time, many traditional infrastructure assets—such as utility or power companies—still need to source additional financing, too.
We see a massive gap between infrastructure investment and the demand for fresh capital, estimated to be nearly US$3.6 trillion.4 This shortfall creates an opportunity for seasoned managers with specialized operating knowledge. For investors new to this asset class, it’s essential to work with experienced managers that can navigate the complexities of infrastructure types and ensure adequate diversification.
- Private credit: Providers gain more pricing power
As the two traditional sources of credit financing are less available—public markets and banks—more companies are turning to private credit. Greater uncertainty and lower bond issuance in public markets have already begun to increase demand for private capital alternatives. High yield bond issuance, for example, dropped by 78% year-over-year between 2021 and 2022; leveraged loan issuance fell by 70% during the same period.5 Meanwhile, banks are experiencing liquidity issues not seen since the 2008 Financial Crisis.
In periods of economic and market stress, private credit managers with capital to deploy can demand more favorable terms (including higher premiums) on the loans they provide. Those with underwriting and public market knowledge are poised to take action, especially in the event of a sell-off in high yield bonds and leveraged loans.
Even if rates remain unchanged, we expect more distressed credit or “special situation” opportunities to emerge. These shifts may help differentiate performance for credit funds launching in 2023.
We can help
As always—but especially in alternatives—due diligence and selectivity are essential, as performance can vary widely.6
If you would like to explore the possibility of investing in private markets, speak to your J.P. Morgan team to determine which strategies would be the most appropriate to help you meet your long-term financial goals.
1 Bain & Company, Global Private Equity Report 2023.
2 Bain & Company, Global Private Equity Report 2023.
3 Top- and bottom-quartile private equity managers, for example, have had, on average, a 21% performance differential. In hedge funds, the difference is 13% between top-quartile and bottom-quartile performing managers. Sources: Burgiss, NCREIF, Morningstar, PivotalPath, J.P. Morgan Asset Management. Data as of November 30, 2022. Manager dispersion for hedge funds is based on annual returns over a 10-year period ending 3Q 2022. Global private equity is represented by the 10-year horizon internal rate of return (IRR) ending 2Q 2022. Past performance is no guarantee of future results. It is not possible to invest in an index.
4 Sources: McKinsey Global Institute, J.P. Morgan Asset Management. Data is based on availability as of August 31, 2022.
5Bain & Company, Global Private Equity Report 2023.
6 Top- and bottom-quartile private equity managers, for example, have had, on average, a 21% performance differential. In hedge funds, the difference is 13% between top-quartile and bottom-quartile performing managers. Sources: Burgiss, NCREIF, Morningstar, PivotalPath, J.P. Morgan Asset Management. Data as of November 30, 2022. Manager dispersion for hedge funds is based on annual returns over a 10-year period ending 3Q 2022. Global private equity is represented by the 10-year horizon internal rate of return (IRR) ending 2Q 2022. Past performance is no guarantee of future results. It is not possible to invest in an index.
