alternative markets review 2021

Hedge Funds
Hedge funds had a great 2021 and managed to set a record high in its AuM. As of the third quarter in 2021, the AuM of the industry is expected to be between $4.3tn and $4.6tn depending on the sources. According to BarclayHedge, the industry’s AuM just surpassed the $4.5tn mark at the end of the third quarter. This is a steep increase from just $3.8tn in 2020, as shown in Figure 6. This is a gain of more than 18% in less than a year. It is expected that the number will rise slightly, once the Q4 2021 numbers are out, as October and November 2021 were rather positive. Nonetheless, December 2021 will have dampened the results of Q4 2021. Generally, the industry has gained substantially over the past ten years, despite a rather inferior view from market participants during most of that period. The AuM soared thanks to two reasons. Firstly, the industry saw substantial capital net inflows. During the first three quarters, the industry received $41bn in fresh capital after having received another $19bn in the second half of 2020. Since then, the industry saw net inflows in every quarter, which is stark break from previous years when the industry experienced net outflows in most quarters. In Q4 2021, net inflows rose to $81bn in 2021, according to Eurekahedge. Figure 7 also shows the severe initial impact of Covid-19 in 2020, when accounting for the significantly positive inflows in the latter half of the year. The second reason for the steep increase in AuM is due to the performance of the hedge fund industry in 2021. Hedge funds in 2021 returned slightly more than 10%, making it the third best year in history after 2020 and 2009 according to HFR. This is remarkable, as the year has not been easy with the constant uncertainty and high volatility in the market. In particular event-driven, equity and commodity strategies have performed very well and the high beta strategies within their respective sector. Figure 8 summarizes the performances of several strategies during 2021 by Eurekahedge. Distressed debt and event-driven strategies performed best with barely any negative performances during the year. Macro and fixed income strategies struggled the most throughout the year, due to the harsh economic conditions. When looking at the highlighted percentiles, it is evident that the high volatility in the market also caused high volatility in hedge fund returns, independent of the strategy. This is most relevant for long short equity strategies whose returns vary between +30% (upper percentile) and -10% (lower percentile) in 2021. Figures 9 to 13 highlight the SMC Strategy Indices in 2021 compared to their benchmarks. The SMC Credit Strategy Index gained slightly more than 5% in 2021, although the variation across strategies is substantial. Two strategies, Trade Finance Crypto and European High Yield L/S Credit did very well in the economic environment, as they reached returns above 12% and 19% in 2021. The Trade Finance Strategy is in particular remarkable, as the strategy has not experienced a negative month since its inception in 2017. The SMC Equity Strategy Index gained closely less than 10%, which is around as much as the average equity strategy in 2021. Within the sector, there was also considerable volatility, due to the sub-strategies. Unsurprisingly, the Equities US Activist Event-Driven performed best with a return exceeding 33%. More tech-focused strategies faced more issues but returned closely below 10% after an extremely successful 2020. Global macro strategies had a tough year and closed only slightly positive for the year. The SMC Global Macro Strategy Index is up almost 37% in 2021, which is largely due to the Discretionary Global Macro Strategy achieving a return of almost 70%. To nobody’s surprise, cryptocurrency strategies performed best in 2021. The SMC Cryptocurrency Strategy Index gained more than 212% in 2021. In the space, it was most important to hold a diversified account of cryptocurrencies to achieve such a great return, as Bitcoin (BTC) gained only 60%. The most successful strategies in the space focused on riskier tokens. The Token and Token Liquid strategies gained 295% and 385% respectively. Despite the great results of 2021, the gains are still inferior to the 342% in 2020. The developments in the crypto space will be discussed in a further paragraph. Lastly, another indicator that the industry is in a healthy state is the fact that the number of launches substantially exceed the liquidations and the number of active funds has reached an all-time high of 22,081.

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RESEARCH PERSPECTIVE VOL. 172 January 2022 Alternative Markets Summary 2021 The topic of 2021 was certainly inflation, at least in the latter half of the year, when it started to get out of hand. As of December 2021, in the US, the CPI’s YoY change is at 7.12%, the highest it has been for 40 years. Figure 1 shows the development of inflation over the past 40 years. This year’s increase is unprecedented and even the surge after the global financial crisis pales in comparison. In Europe and the UK, the situation looks slightly better with an inflation around 5%, but inflation also started to rise later than it did in the US. While many people expected inflation to rise during 2021, few thought that it would rise that high and for a longer time. A high inflation seemed reasonable given how the balance sheet of central banks and money printing soared. In this environment, it also seems unlikely that interest rates are increased significantly to fight inflation. The current global interest rates are shown in Figure 2. Nonetheless, the Fed hinted at rate hikes as early as March 2022, which may bring some alleviation to the inflation issue. Due to this continued support, equities had a great 2021, in particular in the US. The S&P 500, for example, gained almost 25% in 2021 after already gaining 18% in 2020. The previously mentioned actions by the Fed (and central banks in general) have substantially boosted the last two years’ equity returns. The market basically only knew one direction until the end of August 2021. This development was largely due to the continued support for the economy by the government and the Fed. After this bull run, there was a slight correction in September 2021, mainly due to the collapse of Evergrande in China and the potential contagion. This bear market was short-lived, as October 2021 was the strongest month with a gain of almost 7%. The S&P 500 reached many new record highs, the latest being at the very end of 2021 with 4,818. In January 2022, equities saw a substantial decline. The S&P 500 fell below 4,300 at some point during the month. This was largely due to the uncertainties by the actions of the Fed and their two-days meeting on the 26th January 2022 as well as the geopolitical uncertainties between the Ukraine and Russia. Although interest rates will likely not be increased until March 2022, volatility in the market is far from gone. This is also shown in Figure 3. Just ahead of the release of the Fed’s actions, the VIX index peaked at the highest value since a year. Even though volatility is high, public equity markets historically have done well, as shown in Figure 4. It shows a distribution of annual returns. It is in particular remarkable that 71% were years in which US equity returns have been positive. Even though inflation was soaring throughout the latter half of 2021, the gold price barely moved. For the entire year of 2021, the gold price was moving between $1,700 and $1,850 with a few instances, in which the price rose above or fell below this threshold. Although, gold is historically at a very high price, it should be higher given the severity of the central bank intervention and the geopolitical pressure around the world. Thanks to a successful Q4 2021 in terms of gold demand, the asset class did not experience a sharp decline in investor attention of the asset. Compared to the previous quarter, Q4’s demand increased by 50%, a ten-quarter high. Figure 5 shows a summary of the sources of gold demand in the past three years. It is evident that 2019 and 2021 look very similar, indicating that 2020 was an outlier due to the unrivalled market interventions that led to strong interest in ETF products. The underperformance of the asset is also observable when comparing the demand of gold in ETFs between 2020 and 2021. For the latter year, demand is almost inexistent. The increased demand in gold, compared to the previous year, is largely due to jewellery industry. Unlike gold, oil had a great year. WTI crude oil started in the year 2021 with a price around $50 per barrel and ended the year at $75 per barrel. With the current uncertainties in the market, crude oil is on a good way to hit the $90 per barrel, and is already up more than 10% in January 2022 alone. Oil more or less grew over the entire year with occasional bear markets lasting for approximately one month. The most important ones were the Evergreen ship being stuck in the Suez Canal back in March, and the occurrence of the Omicron strain in November. Although oil has gained a lot since its initial downfall at the beginning of Covid-19, it is unlikely that the price will drop soon. So far, the OPEC did not seem to be very interested in substantially increasing the production and thus dropping the price. Moreover, the Ukraine-Russia conflict will certainly not help in this regard. Figure 1: US Inflation from 1982 to December 2021, Source: Eeagli & U.S. Bureau of Labor Statistics, January 2022 Figure 2: Global Interest Rates in 2021, Source: Barron’s Statistics, Tradeweb ICE & US Treasuries, January 2022 Figure 3: VIX Index from February 2021 to End of January 2022, Source: CBOE, January 2022  Figure 4: Pyramid Distribution of US Equity Returns from 1825 to 2020, Source: Markets Tool, Value Square Asset Management & Yale University, January 2022 Figure 5: Global Gold Demand by Sector from 2019 to 2021, Source: Metals Focus & World Gold Council, January 2022 Hedge Funds Hedge funds had a great 2021 and managed to set a record high in its AuM. As of the third quarter in 2021, the AuM of the industry is expected to be between $4.3tn and $4.6tn depending on the sources. According to BarclayHedge, the industry’s AuM just surpassed the $4.5tn mark at the end of the third quarter. This is a steep increase from just $3.8tn in 2020, as shown in Figure 6. This is a gain of more than 18% in less than a year. It is expected that the number will rise slightly, once the Q4 2021 numbers are out, as October and November 2021 were rather positive. Nonetheless, December 2021 will have dampened the results of Q4 2021. Generally, the industry has gained substantially over the past ten years, despite a rather inferior view from market participants during most of that period. The AuM soared thanks to two reasons. Firstly, the industry saw substantial capital net inflows. During the first three quarters, the industry received $41bn in fresh capital after having received another $19bn in the second half of 2020. Since then, the industry saw net inflows in every quarter, which is stark break from previous years when the industry experienced net outflows in most quarters. In Q4 2021, net inflows rose to $81bn in 2021, according to Eurekahedge. Figure 7 also shows the severe initial impact of Covid-19 in 2020, when accounting for the significantly positive inflows in the latter half of the year. The second reason for the steep increase in AuM is due to the performance of the hedge fund industry in 2021. Hedge funds in 2021 returned slightly more than 10%, making it the third best year in history after 2020 and 2009 according to HFR. This is remarkable, as the year has not been easy with the constant uncertainty and high volatility in the market. In particular event-driven, equity and commodity strategies have performed very well and the high beta strategies within their respective sector. Figure 8 summarizes the performances of several strategies during 2021 by Eurekahedge. Distressed debt and event-driven strategies performed best with barely any negative performances during the year. Macro and fixed income strategies struggled the most throughout the year, due to the harsh economic conditions. When looking at the highlighted percentiles, it is evident that the high volatility in the market also caused high volatility in hedge fund returns, independent of the strategy. This is most relevant for long short equity strategies whose returns vary between +30% (upper percentile) and -10% (lower percentile) in 2021. Figures 9 to 13 highlight the SMC Strategy Indices in 2021 compared to their benchmarks. The SMC Credit Strategy Index gained slightly more than 5% in 2021, although the variation across strategies is substantial. Two strategies, Trade Finance Crypto and European High Yield L/S Credit did very well in the economic environment, as they reached returns above 12% and 19% in 2021. The Trade Finance Strategy is in particular remarkable, as the strategy has not experienced a negative month since its inception in 2017. The SMC Equity Strategy Index gained closely less than 10%, which is around as much as the average equity strategy in 2021. Within the sector, there was also considerable volatility, due to the sub-strategies. Unsurprisingly, the Equities US Activist Event-Driven performed best with a return exceeding 33%. More tech-focused strategies faced more issues but returned closely below 10% after an extremely successful 2020. Global macro strategies had a tough year and closed only slightly positive for the year. The SMC Global Macro Strategy Index is up almost 37% in 2021, which is largely due to the Discretionary Global Macro Strategy achieving a return of almost 70%. To nobody’s surprise, cryptocurrency strategies performed best in 2021. The SMC Cryptocurrency Strategy Index gained more than 212% in 2021. In the space, it was most important to hold a diversified account of cryptocurrencies to achieve such a great return, as Bitcoin (BTC) gained only 60%. The most successful strategies in the space focused on riskier tokens. The Token and Token Liquid strategies gained 295% and 385% respectively. Despite the great results of 2021, the gains are still inferior to the 342% in 2020. The developments in the crypto space will be discussed in a further paragraph. Lastly, another indicator that the industry is in a healthy state is the fact that the number of launches substantially exceed the liquidations and the number of active funds has reached an all-time high of 22,081. Figure 6: AuM of the Hedge Fund Industry from 2011 to Q3 2021, Source: BarclayHedge, January 2022 Figure 7: Net Flows and Performance of the Hedge Fund Industry from 2020 to November 2021, Source: Eurekahedge, January 2022 Figure 8: Performance Distribution of Global Hedge Fund Strategies in 2021, Source: Eurekahedge, January 2022 Figure 9: Performance of SMC Fixed Income Strategies and Benchmark in 2021, Source: Stone Mountain Capital Research, January 2022 Figure 10: Performance of SMC Equity Strategies and Benchmarks in 2021, Source: Stone Mountain Capital Research, January 2022 Figure 11: Performance of SMC Global Macro Strategies and Benchmarks in 2021, Source: Stone Mountain Capital Research, January 2022 Figure 12: Performance of SMC Cryptocurrency Strategies and Benchmarks in 2021, Source: Stone Mountain Capital Research, January 2022 Figure 13: Performance of SMC FoHF Strategies and Benchmarks in 2021, Source: Stone Mountain Capital Research, January 2022 Cryptocurrencies / Blockchain Cryptocurrencies had a phenomenal year. They started the year 2021 below a market capitalization of $1tn and almost reached $3tn towards the end of 2021. Figure 14 shows the development of the market capitalization of the crypto industry throughout 2021. The industry had two major highs, one in May 2021 and another one in November 2021. At the beginning of the year, the main discussions in the space focused on Bitcoin (BTC) and Ethereum (ETH) to a lesser degree. This is very well observable in Figure 15 that highlights the dominance of certain coins with respect to the total market capitalization of the crypto industry. At the beginning of the year 2021, BTC made up roughly 70% of the entire crypto market and ETH being responsible for another 15%. This has changed dramatically towards the end of 2021, when BTC only accounts for 40% and ETH around 20%. Other coins rarely surpass the 4% threshold and also tend to vary oftentimes. BTC started the year at $29k and surpasses the $60k mark for the first time in March 2021, after which it experienced considerable volatility. This held until May 2021, at which point the first bear market occurred that held until mid-July 2021. At some point during this downturn, BTC was even negative for the year, as shown in Figure 16. Afterwards, a second bull run initiated that brought BTC to its all-time high of almost $69k in November 2021. Since then, the crypto market is in a down period again that bottomed in the past week when BTC fell to almost $33k. BTC had a great year return-wise with a gain of 60%, but it substantially underperformed other crypto-assets in 2021. For example, ETH gained 392% in 2021. ETH started in 2021 at $737 and peaked at $4,892 in November 2021. The first peak in May was mostly caused by BTC, while the latter was caused by many soaring altcoins. This is also the story of the second half of 2021. Discussions were no longer mostly around BTC and ETH, but other newly emerging coins. The most noteworthy prospects at the beginning were centered around Polkadot, a chain that allows different blockchains to interact with each other, and Cardano, which successfully deployed the proof-of-stake consensus mechanism at a large scale alongside further major upgrades such allowing smart contracts. Nonetheless, the biggest winner is Solana. Solana is a relatively new chain with a new consensus mechanism that has the necessary scalability issues entirely resolved. This breakthrough was rewarded by market participants with an annual gain of 11,280%. This was a summary of the performance-aspect of the crypto space but 2021 was also crucial for the development of the industry, even more so than 2020. Back then, it was argued that these assets are now a valid asset class, despite its speculative nature. It is not considered as such an asset anymore, but its high volatility is still the major driver of people being hesitant to treat it as a ‘true’ asset class. As such, many new crypto hedge funds were launched with a lot of success for the most part. It remains an open question for most how they will fare in a true downturn. Some companies, most prominently Tesla and MicroStrategy, have bought BTC, which was an important step for the general acceptance. Moreover, there have been several events that enhance the reputation of cryptocurrencies. One of those was the launch of the first BTC (Futures) ETF in the US, allowing to profit from movements in the cryptocurrency market without actually having to deal with potential security issues (e.g., losing the coin by forgetting the password). Another event was the acceptance of BTC as legal tender by El Salvador, while many other countries, namely China, banned cryptocurrencies entirely (although they are building their own one). Another negative event for the industry as a whole was the Dogecoin mania at the beginning of the year, when Dogecoin was up more than 15,000% at one point. This certainly did not improve the impression that this is a stable market. Decentralized finance (DeFi) was another major topic in 2021, after the sub-industry exploded in 2020 from less than one billion USD to a double-digit billion USD. Figure 17 shows the growth DeFi in 2021 split into its sectors. At the end of 2021, around $240bn were locked into DeFi applications. The majority of this capital is from decentralized exchanges (DEXes), lending and mining applications. NFTs are the last major trend in 2021. Figure 18 shows the daily USD amount spent for NFTs. The industry started to take off in August 2021 and peaked in September 2021, when a daily sales volume of $400m was surpassed. Since then, the volume dropped to mostly between $50m and $100m on a daily basis, despite the fact that the coverage of the topic is not slowing down. Figure 14: Total Market Capitalization of Cryptocurrency since January 2021, Source: CoinMarketCap, January 2022 Figure 15: Bitcoin and Ethereum Dominance by Total Market Capitalization in 2021, Source: CoinMarketCap, January 2022 Figure 16: Bitcoin Price Development in 2021, Source: CoinMarketCap, January 2022 Figure 17: Total Value Locked in Decentralized Finance and Sub-Category since 2020, Source: Defi Lama & The Block Crypto, January 2022 Figure 18: Daily NFT Sales since 2021, Source: NonFungible & HighCharts, January 2022 Private Equity The private equity industry benefited from strong public equity markets and the soaring numbers of IPOs in 2021. This led to exploding private equity deals. In 2021, the deal value reached $804bn, up 70% from the pre-pandemic levels. Even stronger in comparison to the pre-pandemic economy are the exit values which soared by 92% to $767bn. Even though the numbers are from October 2021, the year is already the year with the highest deal volume in history, easily surpassing its prior record year of 2007 with $712bn. In general, the industry has not suffered much from the pandemic, it rather benefited from the strong public equity markets and low interest rates allowing for low financing costs as well as sustaining very high valuation multiples. With the current turmoil in financial markets, private equity may face the issues caused by the pandemic in the short-term future. Thus, the outlook is lower than the current levels, largely due to potential risks ahead. This was observable in lower fundraising and exit activity since Q3 2021. Due to the great results of the industry during 2020 and 2021, despite the pandemic, the industry saw a lot of inflows. As of October 2021, private equity raised $757bn in capital, which is close to its record year of 2018 with $946bn, once the data for the full year is available. Due to the less prosperous outlook, Preqin expects the industry to maintain a slightly lower level in annual fundraising going forward. In 2022, around $645 and in 2026 around $813bn is expected to be raised by the industry. Buyout, growth equity and venture capital remain the core strategies in private equity accounting for more than 80% of capital raised and funds closed in 2021. Figure 19 provides a breakdown of how much each strategy contributes to the total fundraising in the industry. The industry has been very active in deploying capital, as shown by the high deal values in 2021. At the end of 2020, the industry’s dry powder was around $1.7tn. During 2021, another $0.7tn have been raised. Yet, as of September 2021, the dry powder of the industry stood at $1.32tn, emphasizing the large capital deployments in the year. It is not clear however, whether this number is largely due to the activity of industry in finding attractive deals or if it is due to the high valuations the industry is facing currently. With regards to performance, private equity returns have outperformed public market returns in 2020 and 2021. Buyout strategies could take advantage of the beneficial situation for them, namely negative real rates. Figure 20 shows the returns of several private equity strategies compared to the most common public equity benchmarks. Only Secondaries were not able to outperform the S&P 500, whereas all other strategies handily outperformed every public benchmark. The stellar private equity performance was further supported by the additional leverage through low borrowing costs. Moreover, the strong technology sector also contributed its fair share to the great result. As of October 2021, the IT sector accounts for 22% of the public market, while in deals that took place in 2021, it accounts for 39% in private equity. Over the past five years, the sector has delivered almost double the returns the entire public equity market has achieved. Leveraged buyout strategies are seeing a lot of investor interest, due to low financing cost and even lower costs when speaking in real terms. Furthermore, investors are looking for alternatives to fixed income, which shifts demand to private equity in general. Financing costs are expected to stay relatively low, as the Fed’s debt level is very high, and it is unlikely that interest rates are increased by a lot. Thus, buyout strategies are also expected to be prominent actors in the space going forward, as a large amount of capital needs to be deployed and the number of available companies is limited. Private equity has also allocated more interest towards ESG. Especially climate issues have been a huge issue in 2021 with droughts and floods all around the world. The private equity industry is continuously investing more capital to enable the transition to a more sustainable world. In terms of social issues, funds are getting more transparent, as investors require transparency in particular in ESG issues. One example are investments in the funds internal processes to enhance automatization and transparency, especially the ones centered around ESG. Figure 19: Capital Raised and Funds Closed by Private Equity Strategies, Source: Private Equity International, January 2022 Figure 20: Private Equity Strategy Returns vs. Public Market Returns since 2007, Source: Preqin, January 2022 Venture Capital VC is certainly one of the hottest industries at the moment and has gained massive interest from investors. Thus, its AuM rose from $547bn in December 2016 to $1.68tn as of March 2021. Fundraising is a major contributor to the growth in AuM recently. As of Q3 2021, the industry raised $187bn globally, of which $128bn is stemming from the US. The industry saw significant inflows due to the great returns in 2020. This is likely to continue, as this year’s returns were even better. In general, 2021 was VCs best year, both in absolute and relative terms. For example, US fundraising increased by almost 50% compared to 2020, which was the industry’s best year ahead of 2021. The dry powder of the industry substantially increased to $355bn compared to the end of 2016 with $146bn, which is rather unsurprising given the high interest from investors. Nonetheless, in relative terms, the dry powder has actually decreased over time, showing that the industry is not facing issues in terms of the deployment of capital, even though valuations are rising. In spite of large capital inflows, the industry has managed to deploy the capital effectively. As of Q3 2021, the deal value reached a record $476bn, handily outpacing its previous record in 2020 with $314bn. However, the number of deals fell by around 20%; thus, the impact of rising valuations cannot be ignored. Another reason was a slight shift to later-stage investments, possibly due to difficulties in finding new early-stage deals. One reason for the high deal values also lies in the exit opportunities, which came a lot earlier than in other years. For example, compared to the last decade when trade sales were most prominent, exits through IPOs have massively increased to 28%. The majority of those exits have been in fintech, healthcare and IT. Out of these $476bn, $330bn are stemming from US VC activity. The entire industry has experienced a massive bump. The US has also strongly increased in aggregate deal values compared to its history. For example, the deal value in 2020 was just $167bn, as shown in Figure 21. Unlike the global decrease in deals, the US saw significantly more deals than usual, but never as much more as the increase in the aggregate deal value would suggest. As mentioned earlier, valuations are significant contributor to these deal values, as shown in Figure 22. While angel and seed stages saw a minor increase in their median pre-money valuation, the same cannot be said for early-stage VC and late-stage VC, as those have increased by 50%, 75% respectively, in a single year. VC has delivered an outstanding performance since Covid-19. In 2020, the industry achieved a median return of 31.8%, compared to 23% of PE and VC together, according to Preqin. Although 31.8% is great, this was surpassed in 2021 with 37.2% as median return. The great performance of the VC industry is especially visible in the 2021 vintage returns. The top-quartile returns reached 47% and even the bottom-quartile still reached a respectable 15.4%. Unsurprisingly, technology is the driving force behind the stellar returns in VC. Companies in areas like healthtech, fintech, proptech and cleantech are targeted most frequently. Another emerging sector, cybersecurity, is of huge interest and has attracted investment of almost $13bn in 2021 alone. Fintech experienced the highest growth in terms of investment growth, as shown in Figure 23. In 2021, $50bn were committed to sector vs. only $20bn back in 2020. Fintech is of high interest, as most of the financial system is still operating relatively outdated and therefore more expensive. Inducing more technology in this system allows to cut costs massively. Enterprise tech as well as consumer tech have also experienced significant inflows of investments. Enterprise tech saw 120% more capital invested than in 2020 and accounts for $176bn of US VC capital. Similar but slightly weaker increases occurred in consumer tech. Lastly, healthcare and biotech still grew substantially, but not to the degree of the other sectors. This is largely the case, as healthcare was very interesting last year, when the race for finding the vaccination was on. Nonetheless, when comparing the aggregate deal value from 2019 and 2021, the committed capital has still more than doubled, as shown in Figure 25. ESG is also getting continuously more interest, especially in seed investments. The major focus currently is in decarbonization, where many investments flow into electric cars and battery technology. There has also been a movement of newly formed VC funds that dedicate themselves to ESG-compliant investments and they are able to show a link between their returns and integrated ESG metrics. Figure 21: US VC Deal Value from 2011 to December 2021, Source: Pitchbook & NVCA, January 2022 Figure 22: US VC Median Pre-Money Valuations in Million by Stage, Source: Pitchbook & NVCA, January 2022 Figure 23: US Fintech VC Deal Activity from 2011 to December 2021, Source: Pitchbook & NVCA, January 2022 Figure 24: US Enterprise Tech VC Deal Activity from 2011 to December 2021, Source: Pitchbook & NVCA, January 2022 Figure 25: US Biotech/ Pharma VC Deal Activity from 2011 to December 2021, Source: Pitchbook & NVCA, January 2022 Private Debt The AuM of the industry as of October 2021 is expected to be $1.21tn, which is substantially higher than the $975 from September 2020. At the beginning of 2021, the threshold $1tn in AuM was surpassed and suggests that the industry is likely to grow more than 20% in a single year. This finalizes the great growth of the industry, as it annually grew 13.5% for the past decade. Preqin further expects the industry to continue the strong growth and reach $2.69tn by the end of 2026. The majority of this growth is expected to stem from investors seeking a reliable income stream or due to high risk-adjusted returns of private debt. This development is substantial as it outpaces both private equity & venture capital with 11.5% and real estate with 9.1% growth in AuM in the past decade. When addressing the geographical distribution of assets, the US accounts for more than 60% of the industry’s capital and will continue to dominate. Nonetheless, both Europe and Asia-Pacific are likely to grow stronger than the US. Europe will do so by virtue of its consistent double-digit growth and the committed capital to large funds. Asia-Pacific is strongly underrepresented compared to other alternative assets, but investors will seek for other deals in less-developed markets. Fundraising has struggled in 2020, which was not helped by slow deployment of capital initially. In 2020, the industry raised $176bn and $125bn by Q3 2020. This emphasizes the strong recovery in fundraising since Q4 2020. In 2021, this trend has continued and as of Q3 2021, the industry raised $150bn. Thus, it is very likely that the industry will surpass its 2020 numbers. Indeed, Preqin finds that 2021 fundraising numbers do so with $194bn. Similarly to the distribution of total assets, North America raised the lion share of capital. North America raised $81bn in 2021, while Europe only raised $31bn. This is largely due to the current asset distribution of the industry, but also due to lesser restrictions imposed by the US and the fact that most capital is allocated to established funds, of which most are in the US. Fundraising in 2021 is likely to be second-best year of the industry after 2017. The industry is also facing some issues in the deployment of capital since Covid-19 emerged. Nonetheless, 2021 is expected to perform roughly equal to 2020 in terms of transaction values. At first, this seems underwhelming, as 2020 included the direct consequences of Covid-19, which caused the entire industry to stop the deployment of capital and to adapt to new form of doing business. Subsequently, deal activity picked up again, which took the most attractive deals out of the market. Hence, this lack of increased deal making is not necessarily bad, despite being 12% lower than in the previous years. The industry also sees a consolidation in funds and deals, which is to be expected in such a market environment, where established managers are in an advantageous position. This is due to less direct visits, which causes investors to commit to funds and companies they know or that have a good reputation. This makes it more difficult for emerging managers to get capital. The effect of this consolidation is quite large, as the average fund size grew from $668m in Q3 2020 to almost $1bn as of Q3 2021. This is further shown in the fundraising numbers, in which the number of fund closings declined from 255 in 2020 to 202 in 2021. The most important strategy in the industry is direct lending, which accounts for $452bn in AuM. In the current market ecosystem, its properties – stable returns in volatile environments – is highly desirable for investors. Distressed debt is following with $277bn. Distressed debt is also very attractive, though not for the same reasons, as it is inherently risky. However, in market turmoil, there are a lot of opportunities to invest in cheap debt, which makes the strategy more attractive than in a quiet market environment. Private debt performed strong over the past year, as the industry reached an 11.8% return, which shows that the industry performed well in its first test after the global financial crisis. Nonetheless, the test in a highly pressured down-market was dampened by the strong central bank interventions. However, in the past five years, returns in the industry have fallen from around 8.5% to 5%. The two most dominant strategies, direct lending (as the safe option) and distressed debt (as the riskiest option) have driven the exceptional performance in private debt. Both strategies returned around 13% in the past year, as shown in Figure 26. Over the three-year period, the industry has achieved lower returns, due to the issues with Covid-19 and the even further time horizon show a normalization to some degree between the sectors and public equities. ESG is another topic that gains traction in the industry. A survey by the Alternative Credit Council found that 74% already incorporate ESG into their due diligence process and consider it as a core part that adds value. A third of the respondents even offer interest rate discount for ESG-related criteria. Figure 26: IRRs with Different Horizons Comparing Private Debt and S&P 500 Returns, Source: Preqin, January 2022 Real Estate The real estate industry faced a tough 2020 and 2021 was not much better. It started as 2020 closed but managed to get to a positive outlook by a strong Q4 2020. Nonetheless, the trend of fund consolidation continued in 2021. After the reduced growth in AuM in 2020 to $1.09tn, Preqin expects a faster growth going forward. In 2021, the AuM of the real estate industry rose to $1.3tn. This is largely due to the recovery starting in the late 2021 and the upcoming years. It is expected that the industry will recover faster now, as the fatalities and thus the danger of Covid-19 is reduced with the Omicron strain. Preqin estimates the AuM to grow to $1.8tn in 2026. Despite the largely unfavourable economic conditions, the industry performed not too bad, as shown in Figure 27. The equity portion of real estate companies took quite a hit in 2020 with around -10%, which is substantial given that other equity industries had already a great 2020. In 2021, the recovery was strong with 30%, although in sum of the two years, the industry could not profit to a large degree. The income component from real estate remained fairly stable, aside from the initial drop in 2020 and continues at the same level since 2016. This seems quite uneventful, but this is misinterpretation as the income generating sectors have shifted dramatically. Fundraising substantially increased in Q4 2021, despite a low number of fund closings. In terms of fundraising, Preqin expects difficulties in the coming years. Even though, there are issues ahead and fundraising was moderate, except in the last quarter, the industry still raised $176bn in 2021. It is unlikely that the record fundraising of 2019 with $188bn will be beaten, once the data for the entire year is available. In 2022, it is expected that fundraising will grow at a constant rate. Fundraising was especially difficult for first-time managers, due to the trend of consolidation. In order to achieve their funding goals, first-time managers had to occupy niche strategies. This trend was also evident in the fundraising breakdown by strategy, as opportunistic strategies raised the most capital with 31%, slightly ahead of value-added strategies with 30%. Value-added strategies were of high interest due to their strong improvements in ESG implementation. One large contributor to this surge in ESG awareness comes from the conclusion that the real estate industry is threatened by the increased frequency of natural disasters and that the industry has a lot of potential to mitigate the human-made negative impact on the climate. This became especially evident through the heatwaves in the US and Australia and the huge floods in Europe and Asia in 2021. Proptech is a promising approach to relieve some pressure caused by buildings, which are still considered as being the major contribution to greenhouse gas emissions. The industry also sees this development as one of the major factors for future growth in the industry. Technological adaption can increase the resource efficiency. It can be also used to evaluate potential deals, which is currently its most used adoption. The deployment of capital is still a major issue in the industry, as in 2021 the aggregate deal value was only $278bn compared to the peak of $464bn in 2019. This is further dampened by the fact that most of the large deals were portfolio deals and not individual transactions. The real estate industry is still facing pressure from Covid-19 and the change in behaviour it triggered. In particular the retail sector is threatened, as many people now favour online shopping and making retail rather obsolete. It will require further time, until a significant fraction of people will return to actual stores instead of buying online. Similar developments have been observed in the office sector, due to more working from home, which is also likely to persist. However, the industry is well positioned going forward. If interest rates stay relatively low and the macroeconomic environment will stabilize, the real estate industry is in a good state and may be favoured more by investors than in the current state. These developments have also resulted in other sub-sectors gaining attractivity. The most obvious one is logistics, which profits from the increased e-commerce. Another example are data centers, whose attractivity is slightly increased by Covid-19, due to working from home and the increased data flows and storage. Multifamily housing, a key component of real estate in the US and Europe, is also gaining traction, due to its constant and resilient income stream. In particular in Asia, where there is little institutional ownership, opportunities will arise on a large scale. In a recent survey by Preqin, investors are looking to allocate capital in Asia-Pacific markets. In particular, China, Japan and Australia are of interest. Figure 27: US Real Estate Returns and Economic Growth from 2000 to 2022 (estimated), Source: NCREIF, NAREIT, Bureau of Economic Analysis, US Department of Commerce, PwC Investor Survey, January 2022 STONE MOUNTAIN CAPITAL Stone Mountain Capital is an advisory boutique established in 2012 and headquartered in London with offices Pfaeffikon in Switzerland, Dubai and Umm Al Quwain in United Arab Emirates. We are advising 30+ best in class single hedge fund and multi-strategy managers across equity, credit, and tactical trading (global macro, CTAs and volatility). 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