Staying on track in a world of change

Investors making long-term decisions in illiquid markets have much to consider as they begin 2021. Covid is intersecting with deep shifts in the economy and society, driving changes that span asset classes and reach well into the future. We believe an integrated view of private markets is especially important now, and in early January we convened investors from across our platform to compare their outlooks in a webcast. Following is a summary of the discussion between Jim Barry, CIO of BlackRock Alternative Investors (BAI) and Global Head of Real Assets; James Keenan, CIO and Global Co-head of Credit; Nathalie von Niederhaeusern, Head of EMEA for Private Equity Partners; and Mark Everitt, Head of Investment Research and Strategy for BlackRock Alternative Investors.

How we begin the year

We have seen a major rebound from the first quarter trauma of 2020, in new investment opportunities as well as deployment and valuation levels. Improvements in the underlying economy are feeding through into the financials of many underlying assets. We are also seeing increased competition for investments, placing pressure on returns, though these are still at attractive levels. Competition also means less time to close deals and makes it important to have the investment expertise, relationships and legal resources to move quickly.

Of the multiple trends accelerated by the pandemic, two in particular stand out: digitization and decarbonization, with the latter also helping to increase the focus on environmental, governance and social (ESG) standards more broadly. The path of the pandemic itself remains a major focus, as positive news about vaccines vies with negative news about infection rates, shutdowns and challenges in vaccinating populations at scale.

Digging into deployment

High levels of dry powder in private asset classes put a spotlight on deployment rates. We expect the opportunity set to remain robust.  Our sourcing funnel finished 2020 at around 90% of 2019 levels—noteworthy given the slowdown earlier in the year—and the momentum continues. In early December we asked a group of our senior investors in BAI what they expect their deployment levels to be in 2021. Over 80% of said they expect deployment to be the same or higher than forecasted pre-Covid.

In private credit, for example, we expect to see more opportunities in restructuring and distressed situations, as the effects of shutdowns and structural shifts catch up with more companies. We also expect to see broader private credit markets continue to grow, as more companies (including some with access to public markets) seek the scale and flexibility of the capital now available from direct lenders.

Deconstructing digitization

The shift of activity into the virtual world is among the pandemic’s most profound effects. Even amid competition we continue to find private equity and credit opportunities in cloud computing companies (to name one example), in part by applying a sharper focus to business models and growth prospects.

In real estate, we believe the burgeoning e-commerce market will continue to make the industrial logistics space a favorite. For our part, we are focused on last-mile distribution facilities, where high occupancies and rent growth may benefit logistics landlords. We see location as the main return driver—more so than property quality. In the US, for example, we like properties in the high-barrier and high-income coastal regions, such as Los Angeles and Northern New Jersey/New York. In infrastructure, meanwhile, data centers are evolving as an asset class. We see value in assets servicing large corporate counterparties on a contracted basis. We seek to mitigate risk by targeting data centers able to serve a diverse customer base within the more robust industry sectors, such as life sciences or business services.

Recovery plays

We have seen a broadening of deal types as economic uncertainty lessened in the second half of 2020, and we think this will continue. In real assets we expect investors to look beyond the sectors with Covid tailwinds to take advantage of cyclical recovery in sectors where valuations may have become overly pessimistic—for example, in regional airports. In credit, our private direct lending teams saw a shift from companies seeking liquidity buffers early in the crisis to companies funding growth into the recovery. This year we expect an increase in acquisition activity to boost demand for direct lending. 

In private equity last year, activity was concentrated in add-on acquisitions for portfolio companies, which are perceived to be a less risky strategy and accounted for more than 50% of transactions globally, according to Burgiss. This year we expect more interest in new platform companies, with ongoing appetite for exposure to sectors such as technology and healthcare contributing to the trend. An example is the recent acquisition of a private hospital chain in Europe. The attractive valuation reflected the stresses of the pandemic, and the sector is seen as needing consolidation to help smaller hospitals benefit from economies of scale.

Downside risks and upside surprises

Every outlook needs to look beyond base cases. On the downside, we are alert to:

• Setbacks in vaccine deployment and fighting the pandemic.
• Worse than expected damage from structural shifts—for example, in on-street retail or energy.
• The bill for stimulus, whether in higher taxes, inflation or both.

Upside surprises on our radar include:

• Pent-up demand proves even greater than expected, and impaired sectors come back stronger.
• Unexpected momentum from uptake of 5G wireless.
• Major boost from robust US stimulus and public investment.

In the US, we expect the policies of the incoming Biden administration to have significant effects on markets. In particular, we think an ambitious green agenda could significantly accelerate the global decarbonization trend, with consequences not just in energy, but in everything from real estate to manufacturing supply chains and beyond.