Is there still a spirit of cautious optimism?

“Most economic indicators are still predicting a significant softening of interest rates this year, suggesting a potential turning point in activity levels, which in turn ought to lead to pick-up in deal flow and increased efficiency in the capital recycling process”, says Neil Walker, head of institutional banking in the UK. This will signal a welcome increase in confidence levels more generally after a relatively sedate period of activity in many sectors of the funds market during 2023.

A blurring of the lines between financing mechanisms

Due to prolonged higher interest rates, Net Asset Value (NAV) financing continues to gain momentum. This mechanism allows General Partners (GPs) to borrow against underlying assets, addressing recent liquidity challenges, and facilitating fresh fund generation. Usage of NAV financing hit record highs in recent years, with a 50% increase in deal volume and a 40% growth in average transaction size in 2022, according to data from 17Capital.

“While this trend is expected to continue there are increasingly blurred lines between subscription line, hybrid and NAV financing mechanisms,” Neil says. “This is notably amongst facilities with potential recourse to LPs, predominantly through recallable capital, which are existing up to three or five years beyond their original investment period”. 

This underscores a shift in financing dynamics with heightened flexibility and adaptability needed by funds and lenders.

Secondaries funds likely to continue to prosper

The secondaries funds market is also poised to continue growing at pace given prevailing market conditions and the liquidity picture, with increased demand for alternative sources of debt creating a strong opportunity for the right strategies. 

“There will be an increased requirement for alternative sources of debt, and it will be a case of finding the right equilibrium between those requirements and the risk and reward appetite of those investing,” says Ian Harcourt, senior director, Luxembourg. “So, for those nimbler strategies, who are able to access a wider pool of funding potentially, it is probably a great time to enter the market.”

This is supported by the fact that a number of secondaries funds have successfully closed sizeable rounds of fundraising in recent months. This includes both Ares and Pantheon raising more than $3 billion and Blackstone announcing that it closed its eighth secondaries fund at $2.6 billion.

Ian explains that the recent liquidity constraints and the challenges that has presented to the real estate market in particular, has given rise to the opportunity for GPs to acquire desirable assets at fair market values to build attractive portfolios. 

“The ability for a secondary to be created where it’s a portfolio of assets that have been cherry picked means that as a subsector, it is likely to perform particularly well because of the liquidity constraints and will attract capital.”

A diversifying investor base 

The alternative investment landscape is experiencing a shift with a growing emphasis on diversifying the investor base. High Net Worth Individuals (HNWs) and family offices are becoming increasingly prominent players in this dynamic sector. As traditional sources evolve, the industry recognises the strategic importance of catering to the unique investment preferences and objectives of these sophisticated investors, marking a significant trend in the ongoing evolution of alternative investments.

“Portfolios are probably more diverse than they were three or four years ago when interest rates were near zero,” says Mat James, head of institutional banking offshore. “If you’ve got alternative investment strategies running, the need to attract new sources of funds is evident, so it’s natural that the market is going to look to these types of investors.”

Global tensions, elections and other uncertainties continue to pose risks

Despite these early indications of potential brighter times ahead in the alternative funds sector, broader geopolitical tensions remain a key driver of uncertainty and could pose a threat to investor confidence. 

Both the war in Ukraine and the crisis in the Middle East pose significant risks to the stability of the global economy, and the likelihood of a general election in the UK at some point later in the year (and certainly within 12 months) alongside the Presidential election in the US in November, adds even more uncertainty.

“This backdrop doesn’t make it easy for markets to predict or set expectations with any form of confidence, and you will certainly see some volatility as a result of changing views on the outlook for those economies,” Mat says.

However, Mat points out that the global economy has proven its ability to withstand shocks in recent years. 

“The acceptance of uncertainties is always on investors’ minds now given the recent history of shocks that the system has gone through,” he says.

ESG funding remains a priority  

The focus on Environmental, Social, and Governance (ESG) principles and green finance will remain this year. European banks continue to support funds and assets that positively impact the environment, demonstrating a commitment that extends to the development of sustainable financial products and responsible lending frameworks. 

Furthermore, the tightening of environmental controls, such as stricter building performance standards, will drive investments in higher performing assets or in improving the environmental performance where they do not meet the required levels.  Nature based investments in forestry and climate change adaptation measures, such as carbon capture and storage (CCS) are also expected to continue to attract attention.

“Green financing, whether that be through green infrastructure or ESG funds, will continue as there is still a sense of urgency and a need to help with the transition to net-zero,” says Ian.

Careful planning and consideration will be key this year

Alternative investment funds are showing signs of resilience after the challenges of last year. With inflation generally on a positive trajectory, and rate cuts anticipated later this year, there is a cautiously positive atmosphere. The evolving financing landscape, highlighted by the rise of Net Asset Value (NAV) financing, reflects the sector's adaptability. 

Secondaries funds, especially larger ones, are expected to thrive by navigating strategic pathways amidst liquidity constraints. Despite global uncertainties such as geopolitical tensions and upcoming elections, confidence in the economy's resilience persists.

Get in touch

If you’d like to talk about any of the themes discussed in this article, and how they might impact your organisation, please contact your relationship team.

Explore more insights and analysis here.