by Stephen H. Dover, CFA, Chief Market Strategist and Head of Franklin Templeton Institute, Franklin Templeton
Silicon Valley Bank was a “vital cog” in the private market ecosystem, which leads to many questions—and opportunities—across the alternative investments landscape. Franklin Templeton Institute’s Stephen Dover offers his thoughts.
The collapse of Silicon Valley Bank (SVB) and Signature Bank, an effort to stabilize First Republic Bank, and the recent acquisition of Credit Suisse by UBS have fueled speculation about contagion, raised concerns about the banking sector, and drawn comparisons to the global financial crisis (GFC). We think this is different than 2008; there is not a systemic risk to the financial system, and the aggressive actions over the last several weeks have helped to provide stability to the markets.
What is the impact of these events on alternative investments? SVB was a vital cog in the private market ecosystem. It lent capital to and held deposits for founders, entrepreneurs and multiple Silicon Valley start-ups. According to its website,1 SVB provided funding to 44% of all venture capital (VC)-backed tech and healthcare companies that publicly listed on a stock exchange last year. This creates concerns and opportunities across the alternative asset class.
Private equity: Valuations need to be reset from their lofty 2021 multiples, and the SVB collapse has merely accelerated the adjustment in valuations. Startups will find it more difficult to raise capital. Private companies may stay private longer and struggle to find capital to grow. Secondary private equity may be a beneficiary as founders, family offices, and institutions seek liquidity. Secondary valuations are currently more attractive than other parts of the private equity ecosystem (VC, growth, and buyouts).
Private credit: Amid a flood of cheap money from the Federal Reserve (Fed), years of low interest rates and a pullback in corporate lending from banks, investors in search of higher yields found opportunity in private debt. Private credit surged in size and delivered strong performance relative to traditional fixed income options, in both strong markets and during a challenging 2022. The current market disruptions may present the most attractive investment opportunity for private debt since the GFC.
Private commercial real estate: There have been some structural shifts underway over the last several years, where sectors like retail and offices have been challenging post-COVID-19, and industrial has benefited from the growth of fulfillment centers and research and development (R&D). Rising interest rates and tighter credit conditions hurt overall real estate valuations; however, there is still demand in multi-unit housing, biotechnology, warehousing and R&D that could provide growth opportunities.
Hedge strategies: Market volatility and the dislocations seen in various equities, bonds and currencies may present opportunities for hedge funds. Equity long-short managers are currently positioned relatively conservatively. Event-driven managers are concerned that the instability of the banking sector may limit leveraged buyout and merger activity. Relative value managers have benefited from increased yield, and many managers believe that the Fed’s hiking cycle is close to an end. The banking disruption hurt global macro managers and commodity trading advisors who were short US Treasuries and long equities.
The collapse of SVB was a shock to the banking system and will undoubtedly lead to tighter credit conditions; however, it doesn’t change our long-term view regarding the relative attractiveness of the private markets. Recent events may accelerate a few of the trends already underway, like resetting private market valuations and tighter lending, which may impact financing activities and exits. Certain hedge strategies may benefit from the dislocations in the public markets.
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WHAT ARE THE RISKS?
All investments involve risks, including possible loss of principal. The value of investments can go down as well as up, and investors may not get back the full amount invested. Bond prices generally move in the opposite direction of interest rates. Thus, as prices of bonds in an investment portfolio adjust to a rise in interest rates, the value of the portfolio may decline. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors or general market conditions.
Changes in the financial strength of a bond issuer or in a bond’s credit rating may affect its value.
Investments in alternative investment strategies and hedge funds (collectively, “Alternative Investments”) are complex and speculative investments, entail significant risk and should not be considered a complete investment program. Financial Derivative instruments are often used in alternative investment strategies and involve costs and can create economic leverage in the fund’s portfolio which may result in significant volatility and cause a fund to participate in losses (as well as gains) in an amount that significantly exceeds a fund’s initial investment. Depending on the product invested in, an investment in Alternative Investments may provide for only limited liquidity and is suitable only for persons who can afford to lose the entire amount of their investment.
Investing in private companies involves a number of significant risks, including that they: may have limited financial resources and may be unable to meet their obligations under their debt securities, which may be accompanied by a deterioration in the value of any collateral and a reduction in the likelihood of realizing any guarantees that may have obtained in connection with the investment; have shorter operating histories, narrower product lines and smaller market shares than larger businesses, which tend to render them more vulnerable to competitors’ actions and changing market conditions, as well as general economic downturns; are more likely to depend on the management talents and efforts of a small group of persons; therefore, the death, disability, resignation or termination of one or more of these persons could have a material adverse impact on the portfolio company and, in turn, on the investment; generally have less predictable operating results, may from time to time be parties to litigation, may be engaged in rapidly changing businesses with products subject to a substantial risk of obsolescence, and may require substantial additional capital to support their operations, finance expansion or maintain their competitive position.
Real estate securities involve special risks, such as declines in the value of real estate and increased susceptibility to adverse economic or regulatory developments affecting the sector.
Actively managed strategies could experience losses if the investment manager’s judgment about markets, interest rates or the attractiveness, relative values, liquidity or potential appreciation of particular investments made for a portfolio, proves to be incorrect. There can be no guarantee that an investment manager’s investment techniques or decisions will produce the desired results.
Diversification does not guarantee profit or protect against the risk of loss.
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1. Source: Silicon Valley Bank web site.
