The new year will usher in economic growth at a steadier pace than the whirlwind of the past two years, prompting investors to look outside of traditional asset classes that may be overvalued, according to Cambridge Associates.
The consulting and investment firm told investors to expect slower, but still above average, real global economic growth in 2022 in its annual outlook report.
“Given that most asset classes are overvalued, investors really have to look for niche opportunities to continue generating strong returns,” Serge Agres, a senior investment director at CA, told Institutional Investor. “Usually, that comes in the form of less efficient asset classes, like private investments and venture capital, [and] any type of niche private strategies where you get more bang for your buck than traditional equities in the public space.”
As of June 30, 2021, Cambridge Associates’ U.S. venture capital index had generated a ten-year net IRR of 18.7 percent and a one-year net return of 88.1 percent, the report said. This strong performance has led to record fundraising for VC funds, according to Andrea Auerbach, CA’s global head of private investments.
“As fund sizes and available capital swell and companies choose to stay private for longer, later-stage venture investing has grown, particularly with the emergence of crossover investing, whereby managers invest in a private company prior to and through a public offering,” Auerbach wrote in the report. “While this strategy has been around for some time, it was more episodic and smaller in scale in the past.”
Outside of venture capital, Cambridge Associates expects investors to take advantage of opportunities in private credit. Frank Fama, global co-head of CA’s credit investment group, wrote in the report that investors can mitigate volatility in their portfolios through investments in niche credit strategies that are less correlated with the broader shifts of the market.
“While we believe the economic outlook remains strong, it is not without risks. In direct lending, growing amounts of dry powder are pressuring deal structures and pricing,” Fama wrote. “As a result, we anticipate that commitments to less-correlated private credit funds, such as those focused on life sciences, asset-based lending, and flexible credit strategies, will increase next year.”
Agres agreed, adding that, as CA expects more normalized performance from equities, investors will need to look outside of traditional asset classes to generate strong returns.
“A lot of [investors] look to things like private equity and venture capital, but those have very long lock-up periods,” Agres said. “Private credit fits into a very nice niche there. Even though it’s private, its lock-up period is shorter than private equity, and you’re still getting really good, income-generating returns.”
The public markets, meanwhile, will offer more opportunities for active managers to outperform passive benchmarks, according to Kevin Ely, managing director of public equities at CA. While the Covid-19 pandemic has induced concentration in a select group of sectors, including technology, Ely wrote that he expects a “shift toward more normal earnings contributions across sectors in the S&P 500 index” moving into 2022.
Relative to pre-pandemic valuations, nine out of the index’s 11 sectors had elevated price-to-earnings ratios as of November 30, according to the report. The elevated sectors include communication services, consumer discretionary services, consumer staples, energy, financials, healthcare, industrials, information technology, and materials.
“A wider range of valuation dispersion within sectors and across the market can provide more opportunity for skilled active managers to benefit from stock selection,” Ely wrote.
The new year will also bring with it a greater emphasis on shareholder engagement, according to the report.
Liqian Ma, CA’s global head of sustainable and impact investing research, wrote that as investors become increasingly concerned about systemic risks, such as climate change and social inequality, they will be more inclined to adopt active engagement practices in 2022. Ma said that active engagement looks different from other common ESG practices because it takes longer and is spread across a number of individual shareholders who may hold drastically differing opinions and outlooks.
“Whereas divesting (screening) or proactive investing in positive solutions (impact investing) may lead to immediate outcomes for the portfolio, engagement may be a more nebulous and frustrating activity that may not yield immediate results because each individual investor or institution has limited influence,” he wrote.
Despite these challenges, Ma wrote that investors who implement effective shareholder engagement strategies will prosper in the coming year. “For investors that put in the hard work to refine their direct engagement strategies or back managers that pursue effective engagement strategies, we expect long-term dividends,” he wrote.
As of October 15, 64 percent of fund managers were engaging with companies on ESG issues and 40 percent of fund managers had implemented proxy voting that reflects their firms’ views on social and environmental issues, according to CA data.
“The industry has been shifting to a more activist approach,” Agres said. “The focus is on motivating these companies to change their trajectory to employ more ESG practices, and part of that comes through engagement, voting proxies, things like that, where you can actually change the company from the inside to be more ESG-focused.”
