The fastest growing sections of the alternatives market

Preqin specialises in data, analytics, and research supporting the alternative assets management industry and recently released its special report into The Future of Alternatives in 2027. I spoke to Preqin’s Head of Research Insights, Dave Lowery to learn more about some of the key trends he and his team have seen.

A look to the past

Assets under management stood at $14tr at the end of 2021 for alternatives. Private capital markets experienced extraordinary growth between 2018-2021 with 19.2% per year. Venture capital was a particular standout with AUM growth of 30.9% per year in that period.

1. Low costs for lending increased capital flow into all asset classes, including private markets. This also benefited fundraising in areas like venture capital.
2. Low-interest rates in the past few years forced investors to look to alternatives for sources of income.
3. A decrease in the number of IPOs across global markets, along with solid performance in private markets.

The low-interest rate environment was also positive for a range of asset classes, which is why performance in public equities was strong across the point in time.

A look to future markets

“We’re seeing a rapid deceleration in growth in alternatives and the macro environment is a significant factor in that. It’s a trend we’re seeing across asset classes like public equities and fixed income too.” 

Lowery believes central banks are treading a fine line and its anyone’s guess as to how things will really play out. Inflation is spreading across areas rapidly and to date, rate rises have had little impact in slowing its spread.

For example, private debt typically uses floating rates – a benefit in a period of rising official rates and can be protective of inflation. Alternatives on the whole tend to have a low correlation to public markets and reduce risk in a portfolio. Knowing this, you would assume that investors would flock in this direction but Lowery says this is not necessarily the full picture.

As alternatives prices have not dropped to the same extent as other asset classes, it is now sitting as a higher proportion of investor allocations. In some cases, investors will be at the upper limits of their allocations and may even reduce holdings to adhere to their strategies. That said, those investors who were underweight are likely to start to increase their exposure as a protective mechanism.

Lowery sees enormous potential coming from retail investors who are keen to access the many benefits of alternatives. In fact, he believes they will generate a noticeable portion of flows in the next 4-5 years but regulatory change will be a key factor in creating access (and protecting these investors).

The growth trends

It’s worth noting here that while we’re seeing a drop off in the pace of growth, the alternatives space is still growing. It is tipped to reach $14tr by 2027 with an growth rate of around 11.9% between 2021-2027. That’s hardly small change, even if it’s a sharp drop from the past.

Lowery says the strongest growth is still likely to come from venture capital. 

Preqin’s research indicates that North America will remain dominant for venture capital. Of the funds raised in 2022, 73.2% currently flow to North America and Preqin estimates this will rise slightly to 74% of total funds in 2027. By contrast, European venture capital will take a hit both in growth and in performance. Early-stage venture capital typically struggles more in the current environment because of a rising cost of capital, slower growth costs, and more pragmatic and risk-averse approaches from investors.

Private debt is another area likely to grow in this environment.

Preqin found that nearly half of the institutional investors they surveyed intend to increase their allocations in this asset. Within private debt, they forecast direct lending will see the strongest growth of up to 54% of private debt AUM by 2027 because it offers floating rate exposure, shorter time to maturity and lower risk compared to distressed debt and SS&MD (special situations and mezzanine debt), or other asset classes.

Lowery says that Australian private debt is growing quickly with a lot of demand. Companies like Macquarie (ASX: MQG) and Neuberger Berman have been expanding their footprints here.

“It has something for everyone. It’s inflation linked, it can support the green energy transition and it can offer attractive returns.”

The last year was a record year for infrastructure but Lowery says the market has already surpassed this in the first 6 months of 2022. There are several tailwinds supporting growth in this asset class.

• $23tr in investment is required to meet the Sustainable Development Goals by 2030 and global infrastructure is currently lagging where it needs to be.
• The current energy crisis is supporting the need for energy infrastructure - both from renewables as well as expanding more traditional forms like natural gas.
• In North America, the Infrastructure Investment and Jobs Act alongside the Inflation Reduction Act has created over $1.8tr in federal funding.

The future is still bright for alternatives

Though alternative assets are just as subject to a growth slowdown as other asset classes, it’s hard to view this negatively. For example, a slowdown from around 30% annual growth to 19% in venture capital might be a sharp drop but it’s still a significant rate of growth compared to most other assets. Preqin still tip alternative assets across the board to grow FUM by a CAGR of 9.3% and offer appealing protection and returns in portfolios in the coming environment.

“The good times of the past years are coming to an end and we’re seeing a reset across the board in markets. It is a much needed activity and we’ll see better opportunities, especially in alternative assets, come from this.” Dave Lowery

It’s an interesting space that continues to grow from an institutional and wholesale perspective so it's hardly a surprise that retail investors are looking for access too.