In real estate, industrial asset valuations have barely flinched given low vacancy rates and rising rents, whereas the office space has seen (and is expected to see) further pain as we determine what the future of work will look like.
2022 was characterized by a significant re-rating in public market valuations, but for the most part, private markets were immune. Investors have long debated whether this “private market lag” is a blessing or a curse - some suggest that part of the value of private assets is that they are not marked to market every day, while others view this dynamic as disingenuous or misleading. We would embrace the former view, rather than the latter, as this lower volatility caters to taking a long-term investment view, which has been proven to improve results regardless of whether an investor is operating in the public or the private market.
Venture capital valuations were hit hardest by the increase in rates; this makes sense, as many of these companies are not profitable and do not have profit growth to help offset a decline in valuations. Buyout asset valuations have proven to be more resilient, as rising earnings were able to partially offset downward pressure on valuations. However, there may be a bit of pain ahead, as changes in private markets tend to lag public markets by 2-3 quarters.
Turning to real assets, debt structure and inflation sensitivity have both been key. The combination of an ability to pass on higher costs and a longer-term debt profile has helped insulate infrastructure. In real estate, industrial asset valuations have barely flinched given low vacancy rates and rising rents, whereas the office space has seen (and is expected to see) further pain as we determine what the future of work will look like.
Results in private credit have been mixed, but in general, higher rates have weighed on the value of loans, increasing distressed loan volume and forcing some lenders and borrowers to renegotiate terms given the floating-rate nature of these securities. Turning to hedge funds, higher rates have been supportive of performance. While some underlying fund holdings suffered, in general, higher interest rates are a tailwind for hedge fund performance. Many funds post collateral that earns the rate on T-bills; given the level of rates today, the starting point for returns is therefore more attractive.
In general, higher rates have weighed on alternative assets, although not to the same extent seen in the public markets. That said, given the lagged nature of the relationship between public and private market performance, it is reasonable to assume we are not out of the woods and that more write downs may lie ahead. However, this will undoubtedly create opportunity going forward, particularly for those investors who can look beyond the very near term.