Despite the market turbulence last year, private investments were more resilient to rising interest rates and inflation than their public market counterpartsm according to a market overview by Conshohocken, Pa.-based Hamilton Lane, a leading private equity firm.

The report concluded that private equity's "continued outperformance over public markets, not just in 2022 but across long-term timeframes and through market cycles."

Hamilton Lane also said that, contrary to widespread assumptions about private investments being overvalued, valuations in the sector are generally accurate except for certain growth and venture investments. Private equity-owned companies typically are valued by valuation experts hired by the largest private investors, which makes some skeptical of their objectivity. But valuation experts are aware of these critiques and seek to retain their reputation for fairness. That's one reason private valuations often do not exhibit the dramatic price fluctuations investors see in public markets.

“In a volatile market environment, our data would suggest that private equity would significantly outperform the public markets because we’ve seen that all throughout history,” said Steve Brennan, head of Private Wealth Solutions at Hamilton Lane. “In periods of public market downturn, the spread between the public and private market widens.”

That’s not to say that the private markets have been immune to the turmoil that has overcome most of the markets in the past year. While they are outperforming public equities, the private markets have experienced a slowdown, but it has not been as severe as those on the public side, according to Brennan.

“You are seeing a rationalization of performance,” he said. “It’s just that the private markets won’t be coming down nearly to the levels that the public markets did.”

Another highlight of the report had to do with the valuation of private markets in the first three quarters of 2022. When the numbers for public markets started to decline, many expected the same to take place with private funds. That did not happen because of the price point where private markets were making purchases, the report found.

“Market overview data shows that in most sectors, private market valuations began 2022 at a significant discount to comparable traded assets,” the report said. “Over the course of the year, valuation multiples for public equities and private equities converged.”

In other words, the values for public equities came down to the levels that the private markets were being valued at, according to Brennan.

The report also looked ahead and identified three opportunities in 2023 for private markets: infrastructure, private credit and secondary markets. 

Several factors make infrastructure attractive now, Brennan said. First, governments in both the United States and globally have recognized the need to rebuild their respective infrastructures while there is also a push toward more energy transition and sustainability. Also, infrastructure investments use more contractual structures, which generally perform well during periods of inflation, Brennan explained.

Private credit can produce higher yields during periods of rising interest rates because they have floating rates. Those rates have been steadily rising over the past year. As for the secondary market, Brennan said it is a matter of supply and demand.

“There’s way more supply in the secondary market than there is demand,” he said. “If you are an investor in the secondary market, you are able to acquire high quality equity assets at a much more significant discount than you would have a year or two ago.”

The reason for this supply surplus is due to a denominator effect, the report explained. Many portfolios saw their public allocations decline as the private portion remained relatively constant. As a result, they had to re-balance and sell off their excess private equity in the secondary market.

“If a seller wants liquidity, then they have to be willing to accept a lower price for their assets in order to be able to execute a transaction,” Brennan said. 

The denominator effect is also impacting private markets’ ability to raise funds. Hamilton Lane predicted that 2022 will be a significantly down year for private equities in that area.

Interest rates have also been a factor as the U.S. Federal Reserve aggressively increased rates last year to battle inflation. That has caused a slowdown in deal activity and in particular in the buyout space, according to Brennan. However, indications are that while the Fed may continue to raise interest rates, it will not do so at the same pace, which could give these buyout deals the opportunity to come back. 

“As interest rates level and we get a better understanding of the markets we are operating in from a private equity standpoint, you’ll start to see deal activity pick up in the second half of this year,” Brennan said. 

Looking ahead to 2023, he anticipates that private markets will continue to outperform public equity funds, although given the turmoil of the markets, there are no guarantees.

“We would expect a strong year for private equities relative to the public markets and what they look like from a performance standpoint on an absolute basis is still a little bit too early to call,” Brennan said.