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What Do Falling Rates Mean For Private Markets?

09/10/2024

Q: What Do Falling Rates Mean For Private Markets?

— Forbes-list financial advisor, Colorado

A: With Jerome Powell of the Federal Reserve recently confirming that, “The time has come for policy to adjust,” here are a few things to keep in mind about how falling rates are likely to affect private market asset classes.

Private Credit

Since private credit is floating rate, as rates come down the total yield will come down, assuming no change in credit spreads. Since spreads in middle-market direct lending and real asset lending continue to be healthy, the relative yield of private credit vs. public bonds remains attractive.

Falling rates also relieve some pressure on borrowers which can help to lower the likelihood of non-accruals and defaults. As a result, we expect private credit to offer long-term average returns moving forward.

Private Equity

Since private equity borrows ~40-50% of the purchase price of its companies, the cost of debt has a meaningful impact on private equity returns. Higher rates have meant private equity firms have used less leverage, done fewer deals and sold fewer companies. Buyout private equity returns have been roughly flat in 2022-20231 as a result.

We believe lower rates will drive leverage, deals, exits and valuations higher, helping returns and distributions for buyout private equity investors moving forward. This is true for both primary as well as secondary market private equity managers.

Private Real Estate

While private real estate had historically managed periods of rising rates successfully, the rapid rate rise of 2022-2023 increased borrowing costs on levered real estate positions faster than many commercial real estate properties could increase rents, pressuring valuations. On the positive side, higher rates have also slowed new construction, decreasing new supply to many markets, particularly multifamily and industrial properties.

We believe the valuation reset and outlook for favorable supply/demand dynamics provides a compelling entry point. Falling rates act as a potential tailwind, bringing down borrowing costs and bringing up valuations.

Private Infrastructure

Private infrastructure’s returns were not hampered by rising rates, as the asset class delivered healthy returns in both 2022 (16%) and 2023 (12%, per Preqin).  Inflation escalators and slower fundraising supported such performance.

Lower rates will bring lower borrowing costs and should support valuations given the long duration of cash flows. Long-term contracts that were struck in the higher rate environment are likely to be particularly advantaged. We would focus on increasing demand for power and data based on the global need for sources of clean energy and growing AI demands as the most reliable indicators of continued strong return.

Conclusion

As long as Federal Reserve rate cuts are not in response to meaningful economic contraction, investors should expect real tailwinds to private market performance. Experience tells us that although private markets tend to hold up well in higher interest rate environments, falling interest rates are a boon for all of them.

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The Financial Advisor Solutions Team

Ares Wealth Management Solutions

Carlin Calcaterra

Managing Director, Financial Advisor Solutions Team

Brendan McCurdy

Managing Director, Financial Advisor Solutions Team

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AccessAres is the thought-leadership and educational division of Ares Wealth Management Solutions. The materials distributed by AccessAres are for informational purposes only and do not constitute investment advice or a recommendation to buy, sell or hold any security, investment strategy or market sector. Ares Wealth Management Solutions is a global brand of Ares Management Corporation.

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AccessAres is the thought-leadership and educational division of Ares Wealth Management Solutions. The materials distributed by AccessAres are for informational purposes only and do not constitute investment advice or a recommendation to buy, sell or hold any security, investment strategy or market sector. Ares Wealth Management Solutions is a global brand of Ares Management Corporation.

You are now leaving the AccessAres website

AccessAres is the thought-leadership and educational division of Ares Wealth Management Solutions. The materials distributed by AccessAres are for informational purposes only and do not constitute investment advice or a recommendation to buy, sell or hold any security, investment strategy or market sector. Ares Wealth Management Solutions is a global brand of Ares Management Corporation.