Even though it is anticipating a tumultuous year in the economy, the Franklin Templeton Institute believes there will be opportunities in certain private credit areas, including direct lending and distressed debt, according to its “2024 Alternative Investment Outlook.”
While the outlook predicts a slow economy in 2024, it does not anticipate a hard recession. The economy does, however, face challenges such as weakened economic growth, and that will affect both equities and alternatives equally, Franklin Templeton found.
“Many of the same issues that impact traditional investments also impact alternative investments,” the report said. “Rising interest rates can favor private credit because of the floating-rate nature of most of [the] debt, can hurt commercial real estate as credit conditions tighten, and also negatively impact private equity because of the rising cost of capital to finance transactions.”
Tony Davidow, senior alternatives investment strategist at the institute, said in an interview with Financial Advisor that direct lending is an area of opportunity for investors following the collapse of Silicon Valley Bank last year. The regional bank cataclysm led to a shift in who was providing loans to companies, Davidow explained.
“A lot of the banks that historically have lent to small and middle-market institutions have stepped away from lending, which means private credit managers can step in and be the source of funding for a lot of these opportunities,” he said.
And private managers can dictate the terms, valuations and other details of the loans, he added.
Another private credit opportunity is in distressed debt, since there are expectations that defaults will increase in that space this year.
“That provides opportunities for seasoned managers in the distressed space [whose teams] can renegotiate favorable terms and conditions,” Davidow said.
Private real estate endured its fair share of hardships last year. The office sector was down almost 13% through September and apartments down more than 4%, Franklin Templeton said. But here, too, the report sees a silver lining in the multifamily housing, life sciences and industrials real estate spaces.
The multifamily housing space will likely do well because the country is facing a housing shortage. Realtor.com reported a gap of 6.5 million homes when new construction was compared to new household formations in the decade ended in 2022; Realtor.com added that multifamily housing was one solution to that problem. Franklin Templeton said the need for this new housing will be greatest in states like Florida, Texas, North Carolina and Tennessee, where many residents are relocating.
Lab and production spaces for the life sciences, meanwhile, represent an area for growth since there is an increasing demand for space to accommodate work in the biotechnology, pharmaceutical, medical device and genome research areas, the report found.
And the push into industrials continues as more consumers engage in online shopping, which means warehouses are required throughout the country.
“We believe that the changing economy is driving growth in industrial real estate,” Franklin Templeton said, adding that this represents a “long-term secular trend.”
“Millennials are entering their peak earning years, and consumers will continue to buy goods online, which leads to increased demand for fulfillment centers across America.”
The company also thinks there’s potential for the secondary market in the private equity space, where investors can buy the interests of primary investors—and thus create necessary liquidity in an area where there is famously little.
“The secondary market provided a lot of the liquidity that the overall private equity ecosystem needed in 2023,” Davidow said. “We think the same will be true in 2024. … They will become a vital cog to the overall ecosystem, and we think that there are a lot of attractive opportunities out there.”
Davidow urges advisors to increase alternatives in their asset allocations. He said the traditional 60/40 allocation must evolve with the times given the current market conditions. He points to product innovation in the space and the access that investors now have to institutional quality managers. With all that, he asked, “Why wouldn’t advisors avail themselves of some of these better strategies that produce a differentiated exposure to the market environment?”