Posted by Jina Yoon, CFA, Chief Alternative Investment Strategist
Thursday, September 21, 2023
‘Normalization’ of Capital Raising Activity
After a record setting year in 2021, capital raising activities in private markets have shown signs of slowing down. Some might wonder if this is just the beginning of a secular cool down of the space. And our answer is, it is not. We believe what we are seeing is a ‘normalization’ back to the long-term private market growth trajectory after the exceptional last couple of years. Also, with a greater number of funds expected to close in the near future and some of the markets and participants’ conditions improving, it is reasonable to expect the capital raising activities to remain healthy, albeit in varying degrees by sector.
In the first half of 2023, $502 billion was raised by global private markets. That is below what had been raised during the same time periods in the past couple of years—$639 billion in H1 2022, $545 billion in H1 2021—but is still above what had been raised during the first half of each year in 2020 and before. In addition, it is worthwhile to note the lighter capital raising activity was not a broad-based phenomenon. Sectors like Private Credit and Secondaries showed resilient and growing investor demand, while Venture Capital within Private Equity continued to see lighter activities. This is not surprising given how Private Credit remains the direct beneficiary of tighter bank lending and higher base rates (related LPL Research blog post here) and Secondaries—a strategy focused on buying and selling of fund shares / assets in existing funds—has gained popularity as it continued to grow with broader coverage of sectors and more buyers/sellers with various motivations flocking in.
What Drove the ‘Normalization’ of Capital Raising Activities?
First, we can attribute some of the slow down to the denominator effect. The drop in public markets in 2022 left many investors’ portfolios over-allocated to private markets because they did not re-value lower as much as their public market counterparts. This meant investors had to scale down their future private market commitments, be selective about which sectors and managers they would allocate to, and look to reduce their existing private market holdings, if needed.
Second, some private market sectors faced a more difficult market environment than others, resulting in lighter capital raising activities. After enjoying one of the strongest years in 2021, macro uncertainties, higher funding rates, and banks pulling back from financing large scale levered transactions resulted in Private Equity facing a drought of deals and exit opportunities. This meant investors perceiving the strategy to be relatively less attractive than others as well as them having to wait longer for their locked in capital to come back to their hands to invest in new opportunities. Real Estate was another sector where investors took a more cautious stance as they saw re-valuation slowly taking place since late 2022.
What Are We Seeing Now?
Whether it is economic conditions, policy action, or market performance, divergence remains the keyword for the remainder of 2023, and private markets are no exception. We expect sectors such as Private Credit and Infrastructure to continue to show resilience, while others, such as Venture Capital, wait for more stars to align before re-gaining strength.
That said, we see some constraints easing. With the public equity markets recovering in 2023, investors now have less pressure to rebalance out of their private market positions to bring their portfolios in line with their target allocation between public and private. We see Private Equity and Real Estate valuations stabilizing after the steep re-valuation that took place last year and early this year, closing the gap against their public market counterparts, while providing better entry points for both primary and secondary investors. Especially for secondary markets, we see the market slowly finding better supply/demand balance and narrowing the bid/ask spread, a positive signal for both sellers looking for liquidity and buyers looking to capitalize the discounted pricing in certain sectors that have been beaten down.
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