2024 Private Markets Outlook: From headwinds to tailwinds

Speaker A: Foreign. Welcome to Data Disruption, a, uh, podcast all about data problems, solutions and innovations disrupting the private markets. Let's talk data. Hi everyone and welcome back to another episode of Data Disruption. As always, I'm your host, Kayleigh Jacoby Long and today I'm joined by James Redgrave, VP of, uh, thought leadership and editorial at State street, and Tim Buckner, head of private markets at uh, Charles river, to discuss the findings of State Street's latest private market survey. We have some very interesting stats to share with you today, but first, James, Tim, welcome to the show.

Speaker B: Thanks Kayleigh.

Speaker C: Thanks for having us.

Speaker A: Now for our discussion today, State street has released their third annual private market study. With nearly 500 senior executives interviewed from investment institutions, organizations all around the world, this study has quickly become a huge resource for people to learn about what these executives are thinking, about what their allocation plans are, how they're strategizing data and operations, and what their attitudes are towards global regulatory developments. I have no doubt that just as in years pass, the survey will be packed full of valuable insights. So, James, why don't you kick us off and tell us a little bit about why the survey is conducted each year and what you found the most surprising from this year's results.

Speaker B: You said it largely yourself there. It gives us really, really vital insights into what different types of buy side investment institutions, asset managers, pension funds, insurance companies are thinking, what they're experiencing in terms of their private market investment strategies and their operations. For us within State street, it's valuable stuff. We share this data obviously with the market as well, and we know that a lot of our clients and these organizations find it interesting to see what their peers are sort of saying and doing reflected back to them and what their clients, in the case of the asset owners to the asset managers, are doing. So we've been doing this for three years now and the feedback has always been sort of keep sharing this information with us. In terms of what I found surprising, I think last year and this year we had a look at the macroeconomic environment specifically around inflation and the knock on impact for interest rates. And this year there was a sort of a slight sign of down the line, some of these pressures easing up. But on the whole, a substantial majority of respondents felt approximately sort of 60% to 2/3 of respondents felt that the interest rate environment and the borrowing cost environment, particularly for leveraged investments, was going to remain high for a good few more years to come. A majority felt that inflation was not going to come down to their region's central bank's target rate within the next two to three years. Approximately 55 to 60% said that they'd had material delays in being able to lay out capital, um, structure deals or fundraise as a result of the environment. So the difficult environment which came about post Covid, post Russia, Ukraine, et cetera, is going to persist for several years. But contrary to that, when we broke down what their actual asset allocation plans were and their sort of portfolio growth plans were for all the different sub asset classes that we look at, private market, private debt, real estate, infrastructure, every single one of those sub asset classes across the sort of short to medium term time periods that we examined, these respondents were looking to increase their allocations to, with the exception of on um, the very short real estate. So yeah, you've got this sort of tension in the results between the acknowledgement that things are going to remain hard and that deal making has suffered as a result of the environment, with a continued desire to continue making private markets a bigger portion uh, of their allocations over the next sort of two, three, five years.

Speaker C: One of the more insightful themes I found across this report was just this fast growing importance of risk management across town. Managers and investors are now trying to deal with the current environment that was just described. I found it interesting that 70% of respondents stated that the management measurement of risk has become a uh, top operational pain. And this was regardless of where they were in the world or what sub asset classes that they were operating within. So I just found that really interesting. And then staying on that same theme, risk, I found it also interesting that most almost half honed in on the importance of investment risk, where investors are becoming significantly more selective with investments while returns aren't what they used to be in the years past. And if you kind of think about the market environment, this is all fraught at the same time with some of the highest amount of dry powder on record. You know, we're close to 4 trillion today across private markets of uh, capital ready to be deployed. And so when, when I reflect on that with clients that we've had discussions with, we've seen this bifurcation of a lot of dry powder balanced against this risk management play and where each of them has really started to prioritize significant initiatives around continuous improvement of practices around risk and this consistent scenario and risk modeling to really best understand exposures, best understand performance. So they're much more proactive in an environment like this. So I think we're at a phase of evolution for the market, but at the same time still an environment of Significant growth.

Speaker A: As you both brought up the risk element to the statistics in past new regulations have typically been met with frustration. But I saw in this survey, it revealed that in recent news of upcoming regulatory changes in the private markets, it was perceived more positively as a step forward. Can you all talk to me about what those regulations mean and the potential benefits that they could bring to investors in the broader financial landscape?

Speaker C: When I think about just the U.S. for example, the SEC recently adopted new rules imposing, you know, a significant increase to performance reporting and broader disclosure requirements and also just this, greater frequency and oversight for valuations for each fund. And when thinking about that impact of many clients, these new rules caused a significant revamp of processes and systems to ensure compliance. And it's just been interesting to watch this play out with a lot of organizations and many of which we actually see today in heavy build stages or heavy defined requirement stages so that such that they can actually deploy those systems and new processes to be compliant. And what's interesting is that as organizations are going through those changes, I don't think many of them would actually say that this is a positive step forward. But I would say also having been through with other clients where actually the dust has settled for others, there's clearly a recognition that, uh, it's absolutely been worth it and that significant deficiencies have been existing and needed to be addressed. And so what's interesting is when I reflect about like sort of the last 20 years of private markets growth, even over the last 10 years where we've really tripled how much we've grown, you know, it's interesting is that what got us here will definitely not get us to the next phase of growth. And so I think, you know, the aspiration I would give for all of our clients in all the industry is that these regulations are in fact actually regardless of frustration that it does when you're actually deploying them, um, they actually considerably make you more robust and help you with scale. And given that there's no sign of Slowdown today we're 10% of the public markets at 13 trillion. There's an expectation that we're going to grow to, uh, additional 5 trillion over the next three years. And so as a result of that, I think these regulations will only make us better as an industry.

Speaker B: I definitely pick up on, and the research definitely backs up your point there about the extent to which these things are frustrating. They're still certainly perceived to be worth it. We weren't sort of asking these people whether they liked the additional work that regulation created for Them or the additional sort of spend they had to make on processes and things like that. We asked them whether they thought the regulation was going to be effective in achieving its stated aim. And the two principal sort of stated aims of the regulations that we focused in on were expanding the investor base of private markets out through sort of fund or packaged collective type structures to uh, more retail like sort of quasi retail investor base. And also directing capital markets investment into not just the real economy sort of broadly, but into sort of strategic priorities for the governments enacting these legislations. So we asked whether things like sort of, you know, LTIF 2.0 in Europe per uh, private fund advisor rule in the United States would be sort of successful in those goals. And we also of course uh, asked whether the industry saw significant kind of market for expanding the investor base for private markets. And the answer to both was yes. So yeah, having to get more frequent, more transparent, more timely reporting structures in place from LP to gp, from GP to investor, et cetera, from the asset up, as it were. It's difficult and it's a lift, but it does ultimately open up new sources of investors and new sources of capital for you. And that as Tim just said, is ultimately going to be seen to be worth it.

Speaker A: It seems like regulations will always have a little bit of a necessary evil attitude from the investors. Good hear that. They are believing in the effectiveness though based off the data I saw that North America is expected to dominate in both private market investment deals and fundraising opportunities. What factors contribute to this region's continued prominence in the global investment landscape?

Speaker B: I think that's kind of related to the sort of other trend within the regulations piece we were just talking about actually. So we did sort of look at, not so much looking at now at specific regulations and particular rules, but more generally the overall policy intention to for governments, especially governments in the more sort of market economy based parts of the world to be a little more interventionalist in terms of directing capital market investment to the real economy and to have something more like an industrial policy. Obviously that's a uh, relatively sort of new feature of American sort of macroeconomic policy life. It's not been a feature of it for the last sort of few decades. So there's been a lot of legislative activity in America around infrastructure in particular, several sort of bills passing through and becoming law there, uh, around technology and strategically important emerging technologies and green energy. That's the other big sort of pillar of that. I think the US government has been very active in legislating towards boosting Those particular areas of its economy and private markets, investors are the natural source of capital for achieving those priorities. So I suspect that that's, uh, a big part of why the US Was seen by not just North American respondents, but respondents in other parts of the world as being the likely sort of winner from this particular kind of slightly changed policy framework across the regions.

Speaker C: So James, I think that was an important point. And what I would say is that North American private capital has reached close to 60% of the global AUM as of mid last year. And what's interesting about it is that when you look at the dominance of where that consolidation has occurred, North American fund managers amassed about 70% of the fundraising that happened last year from the market. Of the 1.2 trillion that was raised, 850 billion came from, um, North America. But more importantly, I think that would be interesting is that 50% of those funds was actually raised from the top 25 managers. And I think we'll continue to see a lot of that consolidation. So in addition to the insights that James, you gave, I think it's just interesting that the big keep getting bigger. And several, amazingly within the North American segment have reached or really fast approaching over a trillion under management. And so if you really think about, you know, this combined with US unemployment near record lows and stronger economic growth, and we expect to see much of the same concentration and consolidation, rounding out, uh, 24 and going into 25.

Speaker A: What are some other macroeconomic headwinds that you guys are seeing? Talk to me about the challenges that those present as opportunities for investors today.

Speaker C: I love this question because it really gives us an opportunity to kind of think about the past and also just reflect on what we see coming in the future. And if you reflect on the past, which is a pretty amazing pass, over the last two decades, with interest rates at the historical lows, we've seen AUM, um, in private markets more than triple from 4 trillion to 13 trillion. And then when you think about it like, fund managers were able to raise funds faster and they were able to borrow cheaply. And when you think about the U.S. inflation Reduction act, for example, this spurred close to a half a trillion in private capital being raised for the energy transition. And last year over 50 billion was raised to really accelerate the impact of artificial intelligence in our sector sector. These are just all great examples of the impact that private markets are driving really across the global economy. But if you reflect the current circumstance within macroeconomics in the US Economy, like it's healthy, healthier, I should at least say than most thought. But with inflation and interest remaining stubbornly high, I think private markets is going to grow and take on new shapes and sizes in very different ways, even though it's expected to continue to balloon. And if you think about that, like for allocators, a lot of the allocators are adjusting their capital capital allocations to really prioritize liquidity, but they're really maintaining this strong intent to continue their shift to private markets. From an allocation perspective, we saw that close to 50 to 70% of the respondents continuing this allocation trend and obviously depended by region. But also just on the fund manager side, we're seeing that their attention is turning to longer term value creation strategies, focusing on how strategic portfolio operations can deliver margin through operational efficiencies. And it's not just about expanding through the acceleration of investment multiples as we've seen in recent past. So uh, we're definitely in a very different economic environment than we were in the past.

Speaker B: The point about the long term outlook is definitely a good one. I think when we ask about the headwinds and when I talked in the earlier question about the sort of inflation and the interest rates remaining high, we're looking on a sort of two to three year period in terms of the questions we ask. So clearly the intention to continue investing in these asset classes despite those headwinds is an indication that they're looking out beyond that and into a, I guess, essentially unknowable economic future. And of course if you're going to invest into the long term, there comes a point where you have to sort of stop making sort of detailed assumptions about the growth environment and just assume that the investment is good in and of itself for what it brings your portfolio in terms of returns, in terms of income, in terms of diversification and whatever else it might be. I think the other sort of headwind or challenge that the environment of the last few years has presented to certain elements or certain aspects of private markets. Specifically, insofar as people are uh, or investors, uh, are investing in them for an income stream or a yield. Obviously the environment Tim mentioned where interest rates have been more or less zero in large parts of the world for a decade or more that took interest on cash yields, um, on traditional fixed income securities out of the picture to a certain extent, or reduced their usefulness as ah, an income strategy, obviously they present more of a challenge. But again, going back to what Tim said, private credit is set according to this data for significant growth and um, in certain parts of the world, North America and Europe in particular, it's one of the biggest allocation increase areas for our respondents. So the headwinds are there, but they don't seem to be sort of preventing interest in any of these asset classes really.

Speaker A: So when it comes to investors handling these different allegations with new regulations and all of kind of the things that we've talked about thus far. James, I'm curious, do you have any data on the data of what the private market investors are actually doing with their data, what their challenges are with their information? I love a uh, nerdy call to the data on the data. So talk to me about that. What are the top data challenges for them individually and how, I guess, are they planning to combat those?

Speaker B: We did ask sort of a fairly specific question about what the sort of principal data related challenges that these respondents faced were. And I suspect that a lot of them won't be terribly surprising to the listeners. The frequency and uh, timeliness of valuations, accuracy of valuations, a lot of getting that information if you've got a sort of disparate portfolio of a large number of fairly sort of complex real asset type or privately owned companies, they're not producing data at the sort of speed or the regularity and they're not sort of required to do so in quite the same way as a public company is. So if you're the portfolio manager, it's always been harder to get that data than it has been from a portfolio of listed companies. And if you're the investor within that manager, getting it from the manager. So you've got this kind of chain of data where the desire on pretty much everyone's part part is to make it more frequent, to make it more accurate, to make it more consistent between measurement for comparable types of investment and that sort of thing. And I think one thing that's quite telling on this point is that there was significant interest in being able to view private and public market data together. So to be able to look at a portfolio as a whole thing. Now obviously that's quite difficult to do if you've got sort of a very liquid environment for data from one set of your holdings and much less so than the other one. So I think that sort of indicated to me the, in the same way that people are looking at more sort of retail style investors for their private market sort of product, they're also looking to sort of treat those private market products more like liquid assets in terms of the information they receive, specifically consistency, frequency, all that sort of thing.

Speaker C: I'll just continue to add on to what you just described. I Mean, when I first saw this question and actually reflected on what we heard from last year's private market, uh, survey, it was interesting just to see how the answers had matured as well. Because last year we had asked institutions about the same data challenges they were experiencing. And what was interesting was that two thirds of the respondents talked about their top issue being improving data management processes to build competitive advantage. And more than half talked about just the waste of resources from this manual driven environment that private market spurs. But what's interesting is like this year, as James talked about, like, there clearly is this refinement and emphasis around current environment challenges, which of course we talked about the emphasis on regulations which is now spurring the ever increasing need for regular, uh, valuations. And the timeliness and accuracy of those valuations is getting really emphasized by not just the regulator, but also the investor. And so that's causing a much more intense reshaping of how organizations think about how they execute within that. Because much of the valuations that do occur in our market sector today happen from third parties. So the facilitation of that process, whether it's, whether it's, you know, valuations done internal or external, is something that definitely needs to be systematized and much more an extraction of that data to then be able to run sensitivities against that, uh, has really been a big initiative and a highlight of why data is so important. Also, I would say something that's really mature that didn't come across in the data, but I'll say is very fast emerging today that is just maybe something to highlight for our listeners is that there's this fast and growing importance of what I described at the $50 billion put into the sector around how to use artificial intelligence, really extract unstructured data, uh, coming from a rampant of sources and spreadsheets for that matter, across private markets. And how the use of AI is really showing early signs of being able to accelerate how data is not only ingested but also normalized. And so what we also see in the data coming from organizations is just this maturation of the importance of processing unstructured data and really making sure that that's normalized. Because the only way you ever get to any ability to use a, in natural language models, et cetera, is to be able to have good data and to have that decentralized. And so I would say that what continues to be an important theme for our sector is making sure you have good data centralized and whether we can use AI on the front end or on the back End is a trend I'll talk about maybe, uh, as we wrap up.

Speaker A: The emphasis there on having good data to start with is always a central theme that this show definitely wants to talk about. But as we wrap up talking about this specific survey, what should executives start thinking about from an investment data strategy and execution lens, if that is kind of their base to start with, Maybe

Speaker C: just to continue on with the previous one around data. Like, I would talk about quality over quantity, because if you just think about the past years, there's been a huge emphasis around just getting as much data as possible and then figuring out what to do with it. But quality has become a much bigger theme over the last year, especially given the significant emphasis around larger LP investors coming into the sector and expecting transparency all the way down to the investment level and doing that from both direct and indirect places. Expecting this as the breadth and complexity of this data continues to spur up, uh, from fund all the way down to investment, this expectation of being able to look at performance is going to be high. And so I would just say making sure quality is there is a huge theme for a lot of the clients that we work with and what we expect to be for the industry. And we at State street really do believe that the AI revolution and evolution is here. And it's definitely a hot topic right now to drive operational efficiencies. And especially for organizations that are really struggling with how to combat the current environment and trying to make sure that they get the best out of their organizations, Finding ways in which you can leverage not just AI, but also data to drive far more efficient organizations is going to be key. And we're happy to be talking to organizations about that.

Speaker B: That's pretty much it. It's more data coming faster and knowing what's the good stuff and what to do with it. Data you hadn't got you to call back to the first point you made, or one of the first points you made, Tim. This idea of risk in a portfolio, a relatively minor consideration for a private portfolio manager in the past, now clearly very significant to both the GP and the LP respondents in this survey. So all these kind of things that you think about all the time in the public markets are now bleeding into the private markets. And people are going to have to be able to assess them, measure them, and make decisions based on them in ways that they haven't in the.

Speaker A: Well, fantastic. That wraps up our discussion today over the State Street Private Market Survey for more information about the topics we've discussed today, including the opportunity to read the full annual report, please visit statestreet.com James Tim, thank you for joining me.

Speaker B: Thank you very much for having me.

Speaker C: Thanks for the time.

Speaker A: Kayleigh thanks for listening to this episode of Data Disruption. As you like what you heard, share and leave us a review. It helps others discover the show and I thank you for it. Till next time on Data Disruption.