As the world still faces the rippling effects of COVID-19 and Russia’s invasion of Ukraine, inflation has reached a 40-year high of 9.2% in June. With no certainty of how long this inflationary trend will last, investors may be able to benefit from certain characteristics offered by private-markets assets.
The world of alternative investment asset classes is broad and provides various distinctive advantages when faced with inflation. To steer away from the volatility in public markets, investors should consider the opportunities in private equity, private credit, and infrastructure.
Private equity fund managers have the ability to mitigate harmful external threats to their portfolios. By improving the management of their portfolio companies, having a long-term view on their deals, pursuing geographic (and other) expansions, as well as timing their exits, managers have more flexibility and are able to create more value for their LPs. For example, as inflation affects all sectors and regions differently, a well-diversified portfolio including various geographic focuses, investment stages, and sector focuses can provide great protection.
Looking at private credit, there are three main advantages over publicly traded corporate debt. Investors first get protection from the commonly used floating rate notes structure. This means that the interest rate is variable, thus providing support in a rising rate environment. Investors can also be more proactive in responding to inflation spikes as the investment duration is usually shorter than with equivalent public market investments. Lastly, private credit simply yields higher returns which provide an additional safety margin over a public debt investment. Nevertheless, it is important to bear in mind that with rising inflation and interest rates, comes increased credit risk as input costs and service requirements also rise.
Another attractive asset class in times of high inflation is infrastructure. Demand in this asset class is steady and reliable regardless of the economic cycle as it provides services that can be labeled as essential for society. As infrastructure is less tied to market risks it is less volatile, enabling consistent returns. Recent Preqin reports state that infrastructure represents 21% of private markets fundraising in the first half of 2022, which is a substantial increase from the average of 8% between 2010 and 2021. Aside from diversifying a portfolio, the performance of infrastructure has been proven to withstand periods of high inflation in the past. A Cambridge Associates study revealed a high outperformance of the asset class when high inflation was coupled with low GDP growth. In the long run, infrastructure returns stay well above inflation due to the price inelasticity of demand.
Overall, the long-term scope of private-market investments can offer partial protection from inflation by providing opportunities in sectors, regions, and companies that are well suited to endure such harsh economic periods.