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Can private markets help investors ride the inflation wave?


In this article:

    Demographics, repetitive bouts of fiscal stimulus, and deglobalisation are among the factors pointing to prolonged higher inflation. Can private markets help investors sustain returns?

    Amid higher inflation, volatile stock markets, and recession worries, many investors are looking to invest in assets that are better placed to weather the economic crosswinds. These should include private market investments, particularly high-quality loans and loans to small and medium-sized enterprises.

    Private market investments offer investors attractive characteristics: 

    • The ability to diversify portfolios and invest in sectors that are typically more resilient to rising inflation
    • Access to assets whose performance tends to be uncorrelated with listed equities and bonds. 

    Inflation: a longer-term problem?

    Thanks to the conflict in Ukraine and related sanctions on Russia, gas, oil and other commodity prices have soared, exacerbating the short-term supply shocks driving inflation since last year. Longer-term changes point to economies around the world entering a re-inflationary phase. They include: 

    • Less appetite among policymakers for austerity
    • Fewer working-age people and lower participation rates mean more competition for labour and higher wages
    • De-globalisation, re-shoring manufacturing, and protecting local capacity will drive up production costs
    • Higher carbon prices, costly investment in green energy, and energy shortages could push up energy prices. 

    Together, these factors have led to a consensus view that inflation will exceed the levels of the past decade. We believe the near- and longer-term risks are skewed to the upside. Accordingly, it will become increasingly important for investors to manage this risk.

    Private assets: options for investors

    The correlation between equites and fixed income has become positive over the last two years rather than negative, meaning allocations to these asset classes should be reviewed. This could be an opportune time to look at the benefits of private markets, and investments into SME loans and financing in particular. These can provide some inflation protection, without investors having to compromise on yield or returns.

    The SME lending market has expanded considerably in recent years, resulting in a range of investment options. Funds offer the extra benefit of diversification as they invest in loans across the SME spectrum. In many cases, the lenders are companies that do not participate in listed bond markets – helping investors to diversify their portfolios further.

    With many banks lending for financial rather than investment purposes, loans tend to be robust and flexible. The originating lenders want to maximise the chances of repayment across market cycles and avoid defaults. To date, defaults have not been a significant problem in this area given the lenders’ focus on more resilient companies and sectors.

    Within our SME loans strategy, we are financing leaders in niche markets rather than financing SMEs that are competing with leading players or that rely on large sales volumes and small margins. The focus is on strong cash generation and a high asset value base – in other words, the kind of pricing power that is more resilient to rising costs and commodity prices because of increasing demand.  

    If these companies can withstand inflationary pressures, they will continue to repay their loans, delivering valuable income streams for investors. Sector-wise, that means companies in key areas such as technology, healthcare, pharmaceuticals, business services and education.

    Typically, private market loans are floating rate instruments. However, in the SME loans market, it is possible to move from floating rate to fixed rate options. This may appeal to investors in the current environment and could add extra return with no extra risk.

    We believe that options such as the SME lending market offer investors diversification into private markets, and enable them to be better positioned to weather the current uncertainty.

    Also listen to the Talking heads podcast with Laurent Gueunier, head of real assets, SME lending and structured finance


    Please note that articles may contain technical language. For this reason, they may not be suitable for readers without professional investment experience. Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients. This document does not constitute investment advice. The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay. Past performance is no guarantee for future returns. Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher-than-average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity or due to greater sensitivity to changes in market conditions (social, political and economic conditions). Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation and conservation on behalf of funds invested in emerging markets may carry greater risk.

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