Industry Trends
A look ahead: Credit market trends for 2024
Markets rebounded sharply following the November and December 2023 Fed meetings as the risk of recession receded and rate cuts came into view. Loan and bond issuance set records through the first two months of the year, with credit spreads at their tightest levels since the onset of the pandemic. Much of this activity involved bank-arranged refinancing of loans originated when private credit’s market share increased substantially relative to broadly syndicated loans. Bank disintermediation continues to gather pace, but new competitive fault lines have emerged. It is one thing to disintermediate loans from bank balance sheets. It’s quite another to disintermediate the banks themselves from their most prized clients and customers. As bank balance sheets become more constrained due to regulation and other factors, lending decisions will become even more sensitized to relationship considerations, especially for large banks that derive a disproportionate share of their operating earnings from noninterest income. While this may constrain the growth (or expected returns) of direct lenders competing directly with banks for larger borrowers, it should create more opportunities virtually everywhere else, as private funds partner with banks to assume more of their assets in some areas and displace them entirely in many others.
Source: Carlyle
Private Equity landscape in India: 2024 outlook
The year 2023 continued the H2 2022 trend for Indian private equity and venture capital (PE-VC): Deal activity reduced ~35% from ~$62 billion in 2022 to ~$39 billion in 2023, returning to pre-COVID-19 activity levels. This overall slowdown was primarily driven by global factors, including weakened investor sentiment and persistent macroeconomic headwinds, such as high interest rates, softening consumption, and geopolitical tensions. Looking forward, India remains a comparative bright spot, but PE-VC dealmaking is expected to remain tempered compared to 2021/2022 (amidst global macroeconomic uncertainties). Traditional sectors like healthcare, advanced manufacturing, infrastructure, and renewable energy are expected to continue attracting significant investments due to supportive policies and the emergence of large-scale assets across various sub-segments. Global supply chain diversification is poised to selectively benefit Indian manufacturers in pharma active pharmaceutical ingredients (APIs), electronics, and chemicals with competitive global positioning. Here is the outlook for 2024:
- India PE-VC dealmaking is expected to remain tempered in 2024 amid global macroeconomic stabilization.
- However, traditional sectors such as healthcare, advanced manufacturing, infrastructure, and renewable energy will likely attract outsized investments in India. This is due to positive fundamentals, a supportive policy environment (such as production-linked incentives, tax incentives, etc.), and the emergence of scale assets across multiple sub-segments.
- Furthermore, global supply chain diversification will benefit Indian manufacturers in select, export-oriented sectors such as electronics, pharma (especially in APIs & CDMOs), and chemicals (specialty chem and agrochem). These sectors boast globally competitive Indian-scale players and robust government support.
- Generative AI is increasingly top-of-mind for Indian funds as they actively consider its impact across the private equity landscape, including portfolio value creation, DDs, and internal fund operations.
Source: Bain & Company
The future of private market impact investing: A CEO's perspective
The growing trend of impact investing, particularly in private market impact funds, aims to generate positive social and environmental outcomes alongside financial returns. This market has grown significantly, driven by increasing awareness of global challenges like climate change and social inequality. Major institutional investors, such as pension funds, are committing substantial capital to sustainable investments, with the Global Impact Investing Network (GIIN) estimating the market size to have surpassed $1 trillion under management since 2022. Here are the key trends and essential considerations:
- Growing interest in impact investing: Limited partners are increasingly allocating capital to impact, energy transition, and sustainable solutions, with the global impact investing market surpassing $1 trillion under management and expected to grow at a double-digit rate until 2030.
- Firsts for European impact funds: European general partners and investment firms are launching and closing their first impact funds, with significant commitments to energy transition, clean hydrogen, sustainable agriculture, and other specialized funds.
- Infrastructure draws attention: Major US-based general partners and investors are focusing on energy transition platforms, with large private equity firms adding infrastructure investing capabilities to meet the growing interest in impact investments.
- Sharpened sustainability focus: General partners are prioritizing sustainable, circular, and nature-focused products and services, using traditional operating and commercial excellence capabilities to accelerate growth and scale greener products and services.
Source: World Economic Forum
The 2024 - 2026 venture capital scene
This piece explores significant trends in the venture capital (VC) industry from 2024 to 2026, highlighting the surge in mega-deals and the emergence of highly-valued startups, known as unicorns. In 2015, there were 142 unicorns globally, but by 2023, this number had surged to 1,233, collectively valued at $3.85 trillion. This growth is attributed to larger venture funding rounds, with the number of rounds worth at least $100 million steadily increasing since mid-2020. Equity crowdfunding has also played a significant role, with platforms like WeFunder and StartEngine raising substantial amounts. WeFunder's funding grew from $87 million in 2020 to $738 million by April 2024, while StartEngine has raised over $760 million since its inception. Regulation A+ offerings allow private companies to raise more money but require higher reporting standards. Republic, another crowdfunding platform, has raised over $500 million since 2020, allowing small investors to contribute as little as $10. It also notes a shift in VC investments outside the Americas, with Asia hosting 6,452 VC investment organizations. The number of venture-backed IPOs and SPACs (Special Purpose Acquisition Companies) has also been significant, with 103 venture-backed IPOs in 2020 and a surge in SPACs, although the market saw a 64% drop in 2023 compared to 2022. It concludes that the VC industry is evolving, with changes in deal sizes, IPO numbers, and the rise of SPACs, influenced by financial and demographic factors.
- The Number of Mega-Deals continue to increase: The number of venture rounds worth at least $100 million has been steadily increasing since the second half of 2020, contributing to the rise in highly-valued startups or decacorns.
- Equity Crowdfunding: Equity crowdfunding has become a significant trend, allowing normal people to access venture assets. Regulation CF has led to a surge in equity crowdfunding since 2016, with substantial growth in platforms like WeFunder, StartEngine, and Republic.co.
- Venture Capital Leaving Silicon Valley: There is a noticeable shift of venture capital and startups moving away from Silicon Valley to other regions, including significant growth in Asia-based investment platforms.
- VCs Cashing Out: 2020 and 2021 saw a record number of IPOs and SPAC transactions, with a significant number of deals and investments. However, there has been a notable drop in these activities in 2023 compared to previous years.
Source: Exploding Topics
Market Sentiments
Five alphas: Essential capabilities to succeed in the next era of private capital
Over the past decade, private markets assets under management (AUM) have surged from $3.8 trillion in 2014 to $13.1 trillion, driven by low interest rates and increased deal volumes. Despite entering a slower growth phase with near-term fundraising challenges, private markets’ AUM could triple to over $30 trillion by 2034, supported by new investment needs, capital sources, and private capital’s governance advantage. Firms that fail to triple in size may lose market share and struggle to attract top talent.
To outperform, firms must leverage the “five alphas”:
- Sales Alpha: Raising more capital on better terms by expanding geographical reach, tapping into new investor markets, and innovating with new product vehicles.
- Sourcing Alpha: Creating bespoke investment opportunities through creative transactions and broad product suites, moving away from sector-specific views.
- Operational Alpha: Achieving transformational change in portfolio companies to absorb higher costs and longer investment horizons, requiring precise asset potential views and disciplined return maximization.
- Exit Alpha: Mastering asset monetization through diverse exit routes and systematic re-underwriting of investments, focusing on true cash returns.
- Organizational Alpha: Structuring firms around client-centricity, repeatability, and scalability, with strong governance and succession planning.
Firms excelling in these alphas can achieve outsize growth and returns, positioning themselves as next-generation outperformers in private investing. Despite current challenges, the private capital industry is expected to continue its long-term growth trajectory.
Source: McKinsey & Company
Navigating the competitive private credit market
In this transcript of a podcast episode from Middle Market Growth Conversations featuring Javier Casillas, Chief Credit Officer, and Samuel Goldworm, Managing Director at WhiteHorse Capital, they discuss navigating the competitive private credit market, which has seen significant growth since the financial crisis. WhiteHorse Capital operates with a $12 billion pool, making loans ranging from $30 million to $300 million. To stay competitive, they emphasize a wide and deep origination effort with over 20 originators across various cities, leveraging local networks and relationships. They also highlight their reputation for reliable closing and collaboration across their larger alternatives platform, HIG. WhiteHorse employs a bifurcated model with separate origination and execution teams to avoid groupthink and ensure a thorough evaluation of opportunities. They have 71 investment professionals, with deal teams typically consisting of three to five individuals. This structure allows for rapid and informed decision-making. The firm also organizes its team around industry verticals where specialized knowledge is crucial, such as healthcare, technology, logistics, and e-commerce. This approach helps avoid losses and manage risks, particularly in complex sectors like government-reimbursed healthcare. In handling work-out situations, WhiteHorse maintains consistency and speed, often aligning with business owners to develop recovery strategies. They also address concerns about increased regulation in the private credit sector, noting that the growth of private credit has been a policy success, with appropriate safeguards already in place. The podcast concludes with a note on the importance of regional presence and personal interactions in the origination process.
Source: Middle Market Growth
Alternative investments in 2024: Suggestions on what to watch
The US stock market soared, with the S&P 500 returning more than 26% for the year, and bonds made a remarkable comeback. The catalyst for this unexpected shift? Lower inflation, a surprisingly resilient US economy, and the prospect of easier monetary policy and declining interest rates in the months to come. Looking ahead, private markets have the potential to deliver competitive returns versus public markets, as well as diversification benefits. And, given the current interest rate headwinds, private credit may be a strategy to explore. Investors should consider the risks, particularly liquidity risks, associated with private markets, however, and be prepared to gauge their potential impact on their portfolio. Look across the landscape of alternative strategies and ideas for 2024 and diversify your portfolio with alternative investments such as private equity, private credit, real estate, infrastructure, and secondary strategies.
- Private equity: In a world of opportunity, the potential to access sources of growth
- Private credit: Stepping in when capital is scarce to provide financing
- Real estate: Valuations soften, but overall fundamentals remain relatively healthy
- Infrastructure: Structural macroeconomic transitions help drive potential returns
- Secondaries: Benefiting from an industry in need of liquidity
Source: J.P. Morgan Wealth Management
Market Opportunity/Challenges
High yield structured credit: Ripe conditions within the European market
M&G Investments examines the current favorable conditions for investing in European structured credit, driven by factors such as higher base rates, regulatory changes, market dynamics, and inherent inefficiencies. These conditions are generating increased demand for private and structured credit solutions from both issuers and investors. Structured credit offers potential for excess returns compared to traditional fixed income, supported by strong structural protections and complexity premiums. Investors need specialized skills to analyze and value underlying assets and structure deals to generate alpha. The structured credit market has expanded significantly, offering diverse investment opportunities across consumer and corporate lending, including loans, leases, mortgages, and receivables financing. These investments are typically backed by portfolios of numerous individual loans, providing security through physical or financial assets. The liquidity of these assets varies, and they are often evaluated on a continuum of liquidity rather than being strictly public or private. European banks are facing profitability challenges and regulatory pressures, leading to balance sheet optimization and a shift towards safer assets. This creates opportunities for alternative lenders and capital market-based financing solutions. It highlights the importance of selecting effective structured credit managers who can navigate the complexities of the market and manage risks such as credit and concentration risk. Overall, the structured credit asset class presents compelling long-term opportunities for investors, particularly in areas like residential mortgages and consumer finance, driven by structural themes and market dislocations. It emphasizes the need for expertise in asset sourcing and structuring to capitalize on these opportunities.
Source: M&G Investments
How are the drivers of private equity value creation changing?
EY's report discusses how PE firms are leveraging AI and ESG principles to drive value creation amidst financial pressures and evolving market dynamics. With less appetite for large digital transformations, firms are focusing on maximizing the value of existing technologies. AI's rise has prompted PE leaders to reassess technology priorities, considering AI's potential to disrupt business models, create opportunities, and lower market entry barriers. Practical steps include preparing businesses for AI by generating necessary data and implementing AI strategies to enhance business growth and operational efficiency. Nearly 85% of GPs expect AI to significantly impact their operations in the next five years, though only 4% of CEOs report mature AI strategies. Key priorities for AI include identifying actionable generative AI use cases, pushing for faster tangible benefits, and ensuring data readiness through robust governance frameworks and quality management processes. Concurrently, ESG adoption has surged, with over 2,000 GP signatories to the Principles for Responsible Investment. ESG has evolved from compliance to a core value creation strategy, essential for meeting IPO requirements and attracting investment. Leading firms are implementing comprehensive ESG reporting frameworks, integrating ESG principles into corporate strategies, and staying ahead of consumer and stakeholder demands. It emphasizes PE's relentless focus on value creation, even during extended hold periods, by innovating and optimizing performance to maintain agility and readiness for exit opportunities. This approach ensures that firms can adapt and thrive in uncertain times. Below are the drivers of private equity value creation
- Using sophisticated cash management to increase resilience and drive growth
- Putting costs under the microscope
- Revolutionizing talent management to amplify value creation
- Using AI to power the technology agenda
- ESG is a catalyst of value creation
In today’s market environment, PE’s ability to drive operational value-add is more important than ever. Assumptions put into place 18 months ago may no longer be relevant. Firms need to reassess their strategies, and the ways in which the levers of cash, cost, talent, technology and ESG may need to be reassessed in order to deliver their promised optimal returns.
Source: EY
Artificial Intelligence Scope/ Trends
Private capital innovation: Using artificial intelligence can accelerate the portfolio valuation process
Deloitte discusses the transformative potential of artificial intelligence (AI) in private investment firms, particularly in portfolio valuations. By mid-2023, less than 10% of private funds had integrated AI into core functions, but Deloitte predicts that up to 25% of private equity firms will use AI for portfolio valuations within five to seven years. AI can increase the frequency of valuations, enhancing transparency and compliance with evolving regulatory requirements. The SEC and other global regulators are pushing for more disclosures and transparency, which AI can facilitate by providing timely and holistic valuations using both financial and nonfinancial data. AI adoption is expected to grow at a 30% compound annual growth rate, with 40% of firms using AI for complex tasks and applying it to portfolio valuations. This shift could attract more retail investors by addressing concerns about transparency and liquidity. More frequent valuations can mitigate the denominator effect, where valuation drops in one asset class make others appear overallocated, prompting unnecessary portfolio rebalancing. However, the integration of AI introduces risks such as model and cybersecurity risks. Proper controls and oversight are essential to avoid financial penalties and reputational damage. The SEC is scrutinizing AI use in marketing, algorithmic models, and compliance training. Industry-leading practices and self-regulation are recommended for responsible AI use. Overall, AI-driven frequent valuations could benefit retail investors, limited partners, general partners, and regulators by providing more timely and accurate information, potentially transforming private capital from an opaque asset class to a more transparent one.
Source: Deloitte
