Solid Start to 2017 – Global equities delivered solid gains in the first quarter amid an upswing in global economic data and continued optimism for fiscal reform. US equities advanced to fresh all-time highs, supported by improving manufacturing activity and wages, the end of a corporate earnings recession (five-quarter slump) and finally President Trump’s plans to cut taxes and regulations. Oil prices stabilized near US$50 per barrel, as production cuts helped to establish a floor. Improvements in emerging market (EM) growth resulted in a synchronised upswing in global economic data. Combined with the pause in the upward trajectory of the US dollar, this provided a good backdrop for EM equities.
Global government bond yields fell as prices rose despite the positive economic data and the US Federal Reserve raising interest rates by 0.25% in mid-March. European sovereign bonds came under pressure amid political concerns. Precious metals finished in positive territory, with gold (+8.3%) and silver (+14.2%) both posting gains.
Unlocking Return Potential In Private Equity – As the eight-year bull market accelerated, equity investors enjoyed one-year returns well above the long-term average. However, prospects for an extremely challenged return environment going forward continue to build. Nearly every metric points to more muted returns over the next few years, for example;
- Trailing 8-year annualized returns for US and global equities were 19.5% and 13.4%, respectively.
- Cyclically-adjusted price-to-earnings ratio is over 29x versus a 17x average.
- Warren Buffet’s market capitalization to gross domestic product ratio continues to hover near historical highs.
Combined with rising debt levels and the headwinds of demographics, it’s no wonder highly touted strategists have tempered their expectations for returns. Boston-based asset management firm, GMO, disclosed that its 7-year annualized return forecast for stocks is -4%. Blackrock is predicting that a traditional 60/40 portfolio of US equities and diversified bonds will return less than 4% annually over the next five years.
Nevertheless, public equities will remain a core component in our portfolios due to their liquidity and relative low cost. But, investors will need to look over longer investment horizons for growth. As such, the attributes of private equity become more attractive.
Private equity is an asset class consisting of equity and debt investments in companies, infrastructure, real estate and other assets. The allure of private investments is the outsized return potential and low correlation with public equities. However, like any investment, higher reward is associated with higher risk and commitment.
- Unlike investing in publicly markets, private equity investors often need to provide strategic, operational, and financial expertise to add value to the entity.
- The scarcity of information and disclosure with private investments requires more complex and resource-intensive research and monitoring than public investments.
- Pooled private investments typically feature reduced transparency and higher fees relative to public pools.
- A time horizon of not less than 10-years is often required to realize gains on a transaction.
To offset these drawbacks, the return premium over public equity is generally 15% per year.
GMG views the following as important drivers of successful private equity investing:
- Alignment of Interest: The limited control, less regulatory oversight and long-term nature of the asset class requires substantial alignment between operators and investors.
- Manager Selection: For investments in a private equity pool, rigorous due diligence on the manager, strategy, track record and offering provisions is essential.
- Competitive Advantages: For direct investments, high barriers to entry, niche positioning and strong management will help protect companies that offer proven or innovative products or services.
- Good Exit Potential: Investors should be convinced that a suitable exit can be found at the end of the holding period.
As prices for variety of traditional asset classes become more stretched, investments that can appropriately compensate investors for placing their capital at risk are more scarce. We believe private investments are a solution, if the valuation is appropriate.Download PDF Version