Valuations are at their peak after an eight year bull run, providing good reason for caution in private markets, a StepStone Group partner has said.
The group’s San Francisco-based real-estate partner, Brendan MacDonald, said fund managers were sitting on record dry powder 10 years beyond the GFC, with near-zero interest rates causing asset re-appreciation across most classes, and unusually low volatility where the markets have shaken off major geopolitical events over the last few years.
“It’s the second longest recovery since World War II,” MacDonald told the 2018 Investment Magazine Real Estate and Private Markets Conference, in Melbourne in late February. “Real estate and private markets are reaching new peak valuation levels.
“In all of this is an environment where population growth is projected to slow in the next 50 years, which ultimately should be the driver of returns going forward. In this environment, there are a lot of things you can look at that suggest we should be anticipating and preparing for the next downturn.”
MacDonald also said asset managers need to position themselves to take advantage of appreciation in the next cycle.
Positive signs include “quite strong” GDP growth forecasts in the US and across numerous markets, earnings projections for S&P 500 stocks higher than anything seen in the last several years and accelerating good returns on invested capital, he said.
A substantial drop in transaction volumes in private equity markets showed players had discipline and deals done in private markets had been lower leveraged to withstand a downturn.
“We are not seeing the mega buyouts of 2006-07,” he said. “There are a lot of things we can see in the markets today that would suggest it’s time for caution and time to de-leverage but we believe in not trying to time the market and instead tilt our strategies to more defensive strategy.”
Sunsuper private markets investment manager Scott McNally, told conference attendees the $50 billion fund’s young member base allowed it to take a longer-term view and allocate to private markets, particularly for co-investments in real estate, infrastructure and private capital projects.
“We’re looking to move from 35 per cent co-investment of our private equity portfolio to 50 per cent on a medium-term basis which will come through leveraging co-investment platforms, allocating to funds and separate accounts and also working closely with our own GPs on a primary fund basis,” McNally said.
He explained that emerging markets were still a small part of Sunsuper’s portfolio, with an allocation to Japan and China logistics businesses added last year, but that the fund’s longer-term focus was on Asia.
“We do have exposure [to Asia] but we are underweight in level of transactions globally,” he said. “Longer term we are focused on it. We think there are opportunities there as the market develops, managers get more experience. Asia will certainly make up a larger part of the portfolio going forward based on the wealth and incomes of people in China.”
MacDonald said investors were “turned off” by private real estate markets in emerging economies after previously experienced trouble getting cash out, joint ventures that went wrong and difficulties with the rule of law.
Some Canadian groups and Blackstone had made a play in Indian office markets, however, and Brazil and Mexico had been a focus as asset and currency values recovered. But investors were still largely focused on developed markets.
Private markets had grown substantially as part of investor portfolios since the 1990s, from 10 to 25 per cent, MacDonald said, in tandem with a shift to passive strategies in public and listed funds as investor seek better returns.
He expects the trend to continue.