Q2 Global Market Outlook

La Hoja’s managing partner, Cato Felán attended the iCapital conference in Mexico City earlier this summer. The tone of the conference was cautiously optimistic emphasizing that while there are challenges such as inflation and market volatility, underlying economic growth and supportive central bank policies provide a positive outlook for the near future. The strategic focus remains on identifying and leveraging areas of strong performance across various sectors and asset classes.

The discussion highlighted the growing significance of private market investments and various alternative asset classes in portfolios for achieving beneficial diversification and improved risk-return profiles. Key points from these discussions include:

Private vs. Public Performance

·      Prevalence of Private Companies: In the U.S., private companies dominate the market landscape, with 85% of companies generating over $100 million in revenue being privately held. The trend toward staying private longer has intensified since 2000, with fewer companies choosing to go public compared to the preceding two decades. Additionally, the median age for companies at IPO has increased from 8 to 11 years.

·      Projected Returns: Private equity and private credit are anticipated to yield higher returns than public stocks and bonds. Projected compound returns are 10.1% for private equity and 9.7% for direct lending, compared to 6.3% for US Large Cap equities and 4.6% for US Aggregate bonds.

·      Yield Comparison: Alternatives such as private credit, real estate, and infrastructure are shown to enhance portfolio yield. Data suggests that these alternative assets typically offer higher yields relative to traditional public stocks and bonds.

·      Risk-Return Profile: Alternatives have demonstrated the ability to provide higher returns with comparatively lower volatility than the traditional 60/40 portfolio. Notably, direct lending and private equity exhibit especially advantageous risk-return ratios.

·      Sector and Geographic Exposure: Private markets grant investors significant access to innovative companies that are not yet public, spanning diverse sectors and geographies

Private Credit Panel

The Private Credit Panel discussion focused on the opportunities and attractive yields available to investors who can manage and navigate the risk premium, complexity and market inefficiencies of private credit.

There has been a rapid growth of private credit AUM to record levels in the last 20 years, while income has remained steady through various market cycles. This follows a shift in direct lending following a decline in traditional bank participation and a wave of non-bank lenders entering the space. The panel discussed the interplay between private equity and private credit and provided a 2024-2025 outlook for direct lending. Here are some highlights from the discussion:

Steady High Income and Low Volatility in Private Credit

·      Stability Across Cycles: Private credit has demonstrated consistent performance throughout various market cycles, maintaining stable returns even during economic downturns, making it a reliable component of investor returns. Private credit income has suffered minimal impact from market price fluctuations in the last 20-year period.

·      Historical Performance: in the last 20 years, Direct Lending experienced just one negative return year (2008), highlighting the dependability of its income, which has typically been in the high single-digit range annually.

·      Comparison of Returns: Compared to other types of credit such as high-yield bonds and leveraged loans, private credit, especially Direct Lending, has consistently produced more positive outcomes. This superior performance is attributed to its lower volatility and higher income generation.

·      Lowest Returns Analysis: Examining the lowest 3-year annualized total returns across various credit strategies reveals that Direct Lending provides significant downside protection. Specifically, the lowest 3-year return for Direct Lending was a positive 5%, markedly better than the lowest returns for high-yield bonds (-5.6%) and leveraged loans (-8.2%).

Risk Premium, Complexity and Market Inefficiencies in Private Credit

·      Complexity: The complexity of transactions in private credit, along with the specialized knowledge required to navigate this sector, contributes to the risk premium. This complexity may deter some investors, thereby reducing competition and potentially boosting returns for those adept at managing these intricacies.

·      Market Inefficiency: Private markets are characterized as less efficient due to opaque pricing and fewer market participants. These inefficiencies can provide informed and strategic investors with opportunities to achieve superior returns by identifying undervalued assets before they are broadly recognized by the market.

·      Yield: 10-year average yields for direct lending (10.8%) are significantly higher than high yield bonds (6.4%) or leveraged loans (5.8%), a disparity that underscores the potential rewards for investors capable of effectively managing the risks, complexities, and inefficiencies inherent in private credit.