Private market investors should focus on distressed debt and to a lesser extent secondaries, according to the annual private equity outlook by consultant Wurts Associates, which contrary to other industry observers believes value can be added through top down analysis of the sector.
The report also identifies buyouts as appropriate in this environment if dedicated to small- and mid-markets, although the cost of leverage alongside lower multiples is a concern. But venture capital should be avoided unless compelling manager opportunities present themselves.
“In contrast to other strategies, distressed debt seems relatively well poised to produce strong future returns. Over the next five years more than $1 trillion of high yield and levered loan debt will be coming due, creating a tremendous opportunity set for distressed debt investors,” Eric Petroff, writes director of research, Eric Petroff, in the private equity note.
Petroff also warns of the backward-looking nature of investors, and of the ‘herd effect’ pushing down future returns.
“Not only are returns cyclical due to various systematic factors, but investors have proven themselves to be backward-looking and invariably herd into the most successful strategies, and thus drive down future returns,” he writes.
Wurts’ view is that allocations are most effective when they are made as requisite commitments to meet and maintain targets to private equity, but stay true to strategic weightings by avoiding poorly poised opportunity sets.
While there are some limitations in predicting investment opportunities, Petroff says investors should not confuse the inability to predict the future with a mandate to avoid thinking about it.
“Just because we cannot know the future, this does not mean we can absolve ourselves of the responsibility to think about it. We firmly believe a thoughtful analysis of private markets through the prism of an informed macroeconomic and capital markets outlook is a value added activity,” he wrote in an e-mail response to questions.
