The turnover rate of LP interests as a percentage of NAV is exceptionally small. The cynic will argue, “yes, it’s small, it has stayed small, and it will continue to be small.” First, remember that this is against a backdrop of rising NAV, so the absolute number is growing. But, more importantly, this is a market that continues to mature. Do we all really believe that private equity will be different from the development of other asset classes where secondary turnover grows as participants develop familiarity and structures for liquidity? Nah. We’ll bet on what has happened in every other investment arena, and that is turnover/volume increasing over time. Also, note that a small increase in this turnover figure, let’s say from 2% to 3%, increases the size of the secondary market by 50%.

Still skeptical about the growth of that market? Here’s an interesting data point, and it’s not from us, but from Jefferies, a large player in the secondary space. In the first half of 2022, 48% of LPs were first-time sellers. New entrants will help grow the overall market.

What about the GP-led side?

It’s amazing when you consider this market didn’t exist a short time ago and now represents almost 3% of private market liquidity. Some say it is a bubble, but while we can debate the economics, it is apparent that the transactions being brought to this market have been premier assets, ones that LPs and GPs would want to own. We don’t think that will change any time soon, particularly with the imbalance between supply and demand in this market. Secondary buyers will likely be incredibly choosy about the assets they are willing to finance and buy.

This is another investment arena not to overthink. Invest in secondaries in 2023. Thank us in 2026.

We’ve discussed the diversity of deal flow within the secondary market many times. It is the area of the private markets where the most innovation and creativity is occurring around exits and liquidity options. GP-led deals still represented the majority of deal flow last year. Remember, these deals didn’t even exist 10 years ago. LP-interest deals also increased significantly in 2022, and we expect that trend to continue in 2023. It would be foolish, however, to think GP-led deals might disappear. In an environment where LPs and GPs are searching for liquidity, isn’t it likely that the GP-led market will provide some portion of that? For a GP, it provides needed liquidity and a longer runway for an attractive company. For an LP, it provides liquidity without discounts on your entire GP portfolio. It wouldn’t surprise us to see continued innovation in the secondary market for GP and LP liquidity solutions. This will benefit secondary buyers with the flexibility to toggle to areas where value is the greatest at a given point in time.

We could make the argument (and we will) that we’ve only scratched the surface on secondaries.

We showed this chart last year and recommended framing and handing it out as a holiday gift. No doubt the recipients of such a gift were thrilled. We pointed out that LPs were going to have a numerator effect and be overallocated to private equity because of its incredible performance. Layering in the denominator effect to that situation results in LPs looking to sell, largely to free up capital and/or reduce allocation pressures. This creates motivated sellers even if pricing for LP portfolio deals softens. While, in the past, sellers may have been scared off by the optics of selling at a discount (always fun to pitch that to your board and/or stakeholders), the overallocation pressure and prospect of deploying fresh capital in a lower-priced environment will likely be enough to overcome the bitter pill of selling existing fund interests at a sizeable discount.

But wait again, there’s still more.

A bid-ask spread occurred in the middle part of 2022, as buyers and sellers adjusted to an uncertain market environment, but that spread has narrowed throughout the year, and pricing has come down. Our guess is that pricing will keep softening through the early part of 2023. (That is not to say it won’t keep softening beyond that, but that the early part of the year seems clearer than later. We are masters of the obvious…) But wait, there’s more.

Closed deal volume was down from 2021 levels but still well above any other year in history. In addition, interest in selling assets into this market was enormous, as we saw record secondaries deal flow at Hamilton Lane. That all seems interesting enough, but let’s add the pricing dynamics to this picture.

Let’s turn our attention to an easier subject – secondaries. Let’s also return to that land of Oz, where we discover a market where supply outstrips demand (and by a lot), where prices are coming down (i.e., getting cheaper) and where that dynamic is likely to keep improving as more supply hits the market. What would you say? We’ll spare you the “off to see the wizard” cliché. Let’s head off to Secondaryville.

This is not a dream; this is a world where the supply/demand imbalance is very, very real.

Secondaries

Not such a mystery why many investors are more interested in infrastructure as an inflation hedge, is it? The returns demonstrate a marked increase in most regions during periods of elevated inflation. However, as we just discussed, it will also depend on the type of assets purchased. Not all assets categorized as infrastructure will necessarily result in better performance during inflationary periods, so investors will need to decide whether their infrastructure investment is designed for stable return or for true inflation protection. Both are options within the range of available assets.

We’ll offer two words of caution in this area because, if you know nothing else about us, you know we like to explore both opportunities and risks.

The infrastructure space has had very little in the way of NAV markdowns in 2022 and is an area where prices have remained stable. That alone sends up a caution flag. However, as we’ve outlined, there are strong fundamental reasons why that is rational.

There is a great deal of capital and interest flowing into this area. The contrarian in us makes us look around three or four times when that happens. The thing about contrarians is that they are sometimes right, they are often just wrong, and the good contrarian is one who recognizes when the trend is your friend.

This is likely one of those times.

What makes infrastructure so appealing today, is that governments globally recognize the need to rebuild and enhance their infrastructure, both as a social and competitive issue. There is perhaps no other area of investing with such strong tailwinds behind it.

We’re not typically fans of charts or graphs with lots of words, but as this area is more complex and requires more attention to your investment goals, we’re providing a detailed outline of investment opportunities.

The chart above illustrates the GFC experience, arguably the worst default period in the last few decades. The positive impact from rising rates more than offset that bad period of high defaults. We know past is not prologue, but we bet that this time, it will be really close.

Don’t overthink this one: Private credit is a place to be in 2023.

There’s been plenty of discussion around the increasing demand for private credit, which is a trend unlikely to change over the next few years. There are multiple cyclical and secular reasons why private credit will remain a permanent and growing part of the lending landscape. Banks are withdrawing from the market, a typical trend in down cycles. As companies in need of financing continue to view private credit as a stable, dependable source of capital, the usage will only increase.

Ah, you say, but what of defaults? You paint a rosy picture, Hamilton Lane, but ignore that which has ruined bank credit portfolios – losses during downturns.

The chart above looks at institutional portfolio composition over the last five years. It is hard to find another private investment sector with this scope of assets and geographies. The investment risks associated with road transport differ dramatically from those of an LNG export terminal, particularly one located in Europe or Africa. But it’s all still infrastructure. Further complicating matters from an ESG perspective is whether you are investing in a gas-fired power plant or an onshore wind farm. But yet again, it is all infrastructure.

The infrastructure conversation is a little more complicated, partly because of how broad a category of investments the term “infrastructure” covers.

Infrastructure

The point is that you want to have more allocation to private assets because they perform better, and private credit is no different. Whether you look at nominal or real return, in low or high inflation periods, private credit has done what it was designed to do for portfolios. We acknowledge that the data set for private credit is far shorter in duration than what is available for public credit, but it’s still reflecting more than 25 years of private credit data.

Note the consistency of credit returns whether in up or down markets. Note also, the narrow band of returns in down markets. That is part of what you want in difficult market environments – the investment area that lets you sleep at night without worrying about losses. True, you say, but fixed income is not a safe haven during inflationary periods.

Private Credit

Think how you’d react if we told you, two years ago, that you would enter a land (let’s call it Oz) where these conditions existed:

• Interest rates far higher than they’ve been in years;
• Liquidity slowly leaving the system;
• Companies continuing to need money for all sorts of reasons;
• Equity financing not readily available;
• Public lenders and banks pulling back from the market;
• Credit terms continuing to be more favorable to lenders.

We suspect you’d be singing and dancing your way to see the Private Credit Wizard of Oz to invest.

That’s exactly what you should be doing now.

Private markets investing is not like public markets investing. (It’s OK to be astounded at the genius of this statement. Sometimes we amaze ourselves with such brilliant epiphanies.) In the private markets, you have the ability to tilt portfolios marginally but have to plan those tilts carefully because you can’t shift in and out of assets quickly. In the public market, you can decide to overweight technology in a significant way and change your mind a month later and underweight it instead. You don’t have that luxury in the private markets. You always have a core of managers and assets, plus the ability to shift incrementally, depending on the market environment. The good news is that it’s really not that hard because market cycles really do repeat. Yes, we still contend that to be the case – despite the cries of “this time it’s different, this time is a sea change in the investment world, this time is like no other time.” Don’t believe it.

Let’s look at specific areas.

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