ALTERNATIVE MARKETS SUMMARY – H1 2024

Inflation has been a core topic since 2021, when inflation started to soar around the world. In response to this, the majority of central banks have taken the step of significantly increasing interest rates in order to combat the steep rise in inflation. Between the second half of 2022 and the first half of 2023, these measures, in conjunction with a stabilising economy, contributed to a reduction in inflation. By the end of 2023, inflation had fallen below 4% in most countries, as illustrated in Figure 1. While there have been significant differences in the prior years, the subsequent development has been consistent, albeit with varying magnitudes. In 2024 to date, inflation has stabilised, with most economies showing inflation rates between 2% and 4%. Switzerland is an exception, with inflation closer to 1%. In contrast to earlier expectations, inflation has proven to be more persistent than anticipated, with rates remaining above the frequently targeted maximum of 2%. The most notable exception was the UK, which has been hit hardest by inflation for the same reasons as other economies, but they still had to deal with the consequences of Brexit. Great Britain started in 2024 with an inflation of 4% and has since come down to 2%, where it remains steadily, whereas most other economies’ inflation has remained mostly flat throughout 2024.
As mentioned previously, central banks significantly raised interest rates to combat soaring inflation. The increases commenced at the end of 2021 and continued well into the summer of 2023, and autumn of 2023 for some countries. Since, interest rates were kept at these high levels for most of 2024 with some relief in some economies more recently. In March 2024, Switzerland became the first country to cut interest rates, followed by another reduction in June 2024. It is noteworthy that Switzerland is the only country where inflation has remained below the 2% target maximum since the summer of 2023. In June 2024, the European Central Bank followed suit by reducing interest rates (main refinancing operations rate) to 4.25%. More recently, the central bank hinted at a slower pace of interest rate cuts than anticipated after the initial cut. In August 2024, the Bank of England became the last economy to cut interest rates by 25bps to 5% in response to the promising development in inflation. In the United States, interest rates have remained unchanged since July 2023, currently sitting at 5.25%. The Fed has been hesitant to lower interest rates amid concerns about the stickiness of their inflation, as inflation has remained relatively steady since June 2023. It is also worth noting that Japan's situation is completely different. The country is renowned for its distinctive approach to monetary policy, exemplified by its central bank. The country maintained its negative interest rate throughout the period of the pandemic and its aftermath. In March 2024, the Bank of Japan increased interest rates and followed with an additional hike in July 2024. The first hike was particularly noteworthy, as the country had not raised its interest rates in 17 years. The second hike was to address two issues. The central bank also announced a bond tampering programme to boost the economy and raised interest rates significantly to combat the weakening Japanese Yen.

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RESEARCH PERSPECTIVE VOL. 233 August 2024 Alternative Markets H1 Summary Inflation has been a core topic since 2021, when inflation started to soar around the world. In response to this, the majority of central banks have taken the step of significantly increasing interest rates in order to combat the steep rise in inflation. Between the second half of 2022 and the first half of 2023, these measures, in conjunction with a stabilising economy, contributed to a reduction in inflation. By the end of 2023, inflation had fallen below 4% in most countries, as illustrated in Figure 1. While there have been significant differences in the prior years, the subsequent development has been consistent, albeit with varying magnitudes. In 2024 to date, inflation has stabilised, with most economies showing inflation rates between 2% and 4%. Switzerland is an exception, with inflation closer to 1%. In contrast to earlier expectations, inflation has proven to be more persistent than anticipated, with rates remaining above the frequently targeted maximum of 2%. The most notable exception was the UK, which has been hit hardest by inflation for the same reasons as other economies, but they still had to deal with the consequences of Brexit. Great Britain started in 2024 with an inflation of 4% and has since come down to 2%, where it remains steadily, whereas most other economies’ inflation has remained mostly flat throughout 2024. Figure 1: Inflation Rates in the US, EU, UK, Switzerland and Japan from January 2022 to July 2024, Sources: U.S. Bureau of Labor Statistics, EUROSTAT, Office for National Statistics, Swiss Federal Statistical Office & Ministry of Internal Affairs & Communications, August 2024 As mentioned previously, central banks significantly raised interest rates to combat soaring inflation. The increases commenced at the end of 2021 and continued well into the summer of 2023, and autumn of 2023 for some countries. Since, interest rates were kept at these high levels for most of 2024 with some relief in some economies more recently. In March 2024, Switzerland became the first country to cut interest rates, followed by another reduction in June 2024. It is noteworthy that Switzerland is the only country where inflation has remained below the 2% target maximum since the summer of 2023. In June 2024, the European Central Bank followed suit by reducing interest rates (main refinancing operations rate) to 4.25%. More recently, the central bank hinted at a slower pace of interest rate cuts than anticipated after the initial cut. In August 2024, the Bank of England became the last economy to cut interest rates by 25bps to 5% in response to the promising development in inflation. In the United States, interest rates have remained unchanged since July 2023, currently sitting at 5.25%. The Fed has been hesitant to lower interest rates amid concerns about the stickiness of their inflation, as inflation has remained relatively steady since June 2023. It is also worth noting that Japan's situation is completely different. The country is renowned for its distinctive approach to monetary policy, exemplified by its central bank. The country maintained its negative interest rate throughout the period of the pandemic and its aftermath. In March 2024, the Bank of Japan increased interest rates and followed with an additional hike in July 2024. The first hike was particularly noteworthy, as the country had not raised its interest rates in 17 years. The second hike was to address two issues. The central bank also announced a bond tampering programme to boost the economy and raised interest rates significantly to combat the weakening Japanese Yen. Figure 2: Interest Rates in the US, EU, UK, Switzerland & Japan from January 2022 to August 2024, Sources: Federal Reserve, European Central Bank, Bank of England, Swiss National Bank & Bank of Japan, August 2024 The steeply soaring interest rates also caused significant changes across different maturities. Originally, it was thought that the steep hikes will be answered with quick interest rate cuts, once the biggest challenges were resolved. Hence, yields of bonds with long maturities cannot compete with the yield of short-term bonds. This is particularly evident in US Treasuries. Prior to the interest rate hikes by the Federal Reserve, the yield on long-term bonds exceeded the yield on short-term bonds by approximately 2%. However, once the hikes started, this trend reversed. Since November 2022, the yield curve in the US has inverted, which is a key indicator of an impending recession. Additionally, the magnitude of the inversion is unprecedented. It is also worth noting that such a long inversion is highly unusual, as there has been no return to a 'normal' yield curve since the inversion in November 2022. In terms of magnitude, long-term bond yields are consistently 1% lower, with some instances approaching 2%. This change is shown in detail in Figure 3. The yield on US corporate bonds also followed an interesting trajectory. Investment grade bonds consistently exhibited a premium of 2% relative to the federal fund rate. Once the hikes started, this gap narrowed. By May 2023, yields on investment grade bonds were aligned with the federal fund rate, at times even below. This is also a cause for concern, as it indicates a notable decline in the US's financial stability. High-Yield bonds exhibited a close correlation with Investment Grade bonds, with an additional premium of 2% in most instances, although it reached over 4% in recent times. In 2024, specifically, HY bond yields are declining, suggesting a more robust economic outlook, given the yield's relationship with the default rate. Figure 3: US Yield Curve (10-Year Treasuries – 3-Month Treasury Note) and a Comparison of Yields on US Investment Grade and US High Yield Corporate Bonds, Sources: Federal Reserve of St. Louis & Ice Data Indices, August 2024 The equity markets have experienced significant turbulence in 2024. The majority of 2024 has been characterised by notable success. With the exception of April 2024, equity markets demonstrated consistent growth. This changed abruptly in July 2024, when markets came down significantly. The market downturn reached its zenith on 5th August 2024, with a widespread sell-off affecting nearly every security. The 2024 rally was driven by technology companies, which benefited from increased AI investments and adoption. The robust performance of major technology firms also contributed to further growth. Apart from the technology sector, most other sectors are experiencing a moderate but positive year, with a relatively steady rate of growth. While soaring valuations and economic indicators have not supported such a development in the past few years, at least employment, of the major economic indicators, was showing promising signals for the equity market, although a majority suggested otherwise. More recently, equity markets have exhibited a notable correction, with a pronounced downtrend evident since July 2024. This trend reached its peak in the global sell-off on 5th August 2024. The latter began in Japan, where the Japanese markets crashed, which then spilled over globally. During this period, riskier securities were sold on a huge scale. The sell-off also caused volatility to spike dramatically, with some sources indicating that it reached levels higher than those seen during the 2008 financial crisis or the global pandemic of 2020. Figure 4 illustrates the significant increase in the VIX index, which remained at approximately 10 throughout the year but rose to nearly 40 in August 2024. The graph also provides a comparison of the performance of various US indices with different risk parameters. To date, the Magnificent 7 continue to outperform, with a return of 25% compared to the 10% of the S&P 500 and Nasdaq. Following the recent sell-off, the DJIA has dropped to a return of only 3% in 2024. While all of them are positive this year, they reached much higher levels during the course of the year. In July 2024, the Magnificent 7 were up by over 50%, the Nasdaq exceeded 26%, and the S&P 500 reached nearly 20%. In contrast, the DJIA peaked at a moderate 10%, when the other indices had already begun to decline. This was due to a shift in investor preference from growth to value companies. Figure 4: Performance of the Magnificent 7, the Dow Jones Industrial Average, the S&P 500, the Nasdaq Composite Index, and CBOE’s Volatility Index Since the Beginning of 2024, Sources: Roundhill Mag7 ETF, Standard & Poor’s, Nasdaq, Investing, CBOE, August 2024 In the global market, Japanese equities demonstrated the highest performance, maintaining pace with their US counterparts. By July 2024, the Nikkei 225 had reached a performance peak comparable to that of the Nasdaq, with a 27% increase. Following its peak, the index declined to 13%. Figure 5 illustrates the sharp decline and subsequent recovery of Japanese equities in August. This significant decline was driven by a substantial unwinding of the carry trade between the USD and the JPY. This then triggered a strong recession fear, due to growth concerns on large tech companies, which were the key drivers of performance in 2024. Chinese equities experienced significant volatility throughout the year. At the beginning of 2024, equities were down by 10% following the real estate crisis, but by May 2024, they had grown by 17%. Chinese equities then saw a gradual decline throughout the remainder of 2024, with the year-to-date performance currently flat. In Europe, equity markets have demonstrated greater stability. The Euro Stoxx 50 rose steadily until May 2024, reaching a peak of 15%, and then declined steadily after that. As of the time of writing, the performance of European, British and Swiss equities is equivalent at 5% for 2024. British and Swiss stocks followed similar trajectories throughout 2024, reaching peaks of around 10%. Figure 5: Performance of the Nikkei 224, the Hang Seng Index, the FTSE 100, the Euro Stoxx 50, and the SMI Since the Beginning of 2024, Sources: Nihon Keizai Shimbun, Hang Seng Bank, FTSE Russell, Deutsche Börse Group, Six Group & Investing, August 2024 Hedge Funds H1 2024 Summary The hedge fund industry has performed moderately well in the first half of 2024. Given the upward trajectory of markets in 2024, it is unsurprising that hedge funds have generated positive returns. However, as is often the case, hedge funds become somewhat unappealing to investors in strong bull markets, as they rarely outperform public indices. Although, there has been substantial volatility in financial markets, returns of various asset classes delivered strong performances. This results in a less impressive performance for hedge funds, due to their frequently long-short approach and therefore reduced exposure to the market. This is reflected in a continuous stream of net outflows over the past year, with only a few exceptions. Notwithstanding these outflows, the hedge fund industry succeeded in growing its assets to $5.47 trillion (including $325 billion in fund of hedge funds) as of the Q1 data provided by BarclayHedge. Figure 6 illustrates that the industry has experienced a significant growth of 75% in AuM from January 2020 to March 2024, with a further 5% growth from January 2023 to March 2024. Since the industry's record-setting AuM in March 2022, the industry's AuM has remained relatively steady, largely due to a combination of positive performance and negative outflows. The strategies showing the highest growth within this period were Balanced (Stocks & Bonds), Multi-Strategy, Emerging Markets, and Other, which now manage more than double the assets compared to 2020. Traditional Equity and Fixed Income focused funds increased by around 66%, while Macro funds have declined by 13% compared to 2020. The recent sell-off in financial markets provides an opportunity for hedge funds to demonstrate to investors the potential benefits of the asset class in managing downside risk. Depending on performance, safer and opportunistic strategies have the capacity to generate attractive returns while mitigating losses. This could result in renewed interest in the asset class and further growth through positive inflows. Figure 6: Hedge Fund Assets under Management by Investment Strategy from January 2020 to March 2024, Source: BarclayHedge, August 2024 Since the onset of the pandemic, hedge funds have been subject to heightened volatility. This resulted in significant discrepancies across hedge funds, extending beyond the scope of their investment strategies. As a result, there has been a greater need for careful selection of hedge funds. Figure 7 illustrates the significant divergence in performance among individual funds, particularly during the pandemic. At the peak of performance dispersion in early 2021, top decile hedge funds saw gains of nearly 70%, while the median hedge fund returned 20% compared to 0% for bottom decile hedge funds. While such differences are no longer evident in the market, the selection of hedge funds remains a crucial aspect, as top decile funds typically outperform the median hedge fund by 10% annually and bottom decile funds underperform by 10%. Figure 7: Hedge Fund Industry Dispersion Using 12-Month Rolling Returns from July 2014 to June 2024, Source: Aurum, August 2024 In terms of performance, equity hedge funds demonstrated a strong showing in the first half of 2024. As highlighted in the summary of equities in the first half of 2024, the performance of equity hedge funds was driven by a highly successful underlying performance. Due to the prevalence of long-short equity strategies, net exposure to the equity market is notably lower, which results in a reduced performance compared to equity indices. Furthermore, the robust performance of equity markets was largely driven by the strong performance of major technology companies. By contrast, a significant number of hedge funds adopt dedicated strategies that focus on specific sectors. Consequently, they are not always able to benefit from the strong performance of technology companies, despite these companies being present in many hedge funds' portfolios. It is worth noting that the first half of 2024 was an exceptional period, with the recent drawdown only beginning in July. This is not reflected in the data shown in Figure 8. The SMC Equity Strategy Index returned 6.56% in H1 2024, which is towards the lower end of the range. The performance was negatively impacted by a few individual funds that posted weaker results. The most successful strategies focused on technology, telecommunication, healthcare and employed either a long-short or long-only approach. Those funds achieved performances ranging from 14% to 17%. Figure 8: Equity Hedge Fund Performance as of June 2024, Source: Stone Mountain Capital Research, August 2024 Fixed income took a big hit in 2022 when interest rates started to rise. However, the subsequent decline and new issuance has left fixed income in a promising space. Especially as inflation has eased, offering attractive real returns for investors with lower risk tolerance and to smooth portfolios. So far in 2024, fixed income hedge funds have returned between 1.5% and 5%, depending on the benchmark source. Our fixed income hedge funds returned just over 2% in the first half of 2024. Figure 9 shows a comparison of our strategy index, several fixed income hedge fund indices and commonly used public market indices. Figure 9: Fixed Income Hedge Fund Performance as of June 2024, Source: Stone Mountain Capital Research, August 2024 The Global Macro funds also performed strongly in the first half of 2024. Our SMC Tactical Trading Strategy Index has surpassed 20%, largely driven by the Systematic Global Macro strategy, which has returned 62% so far in 2024. Most other benchmark indices show gains of 4%-7% for CTAs and 1%-2% for Relative Value Volatility strategies. Figure 10 shows a comparison between our Tactical Trading Strategy Index and a selection of benchmarks. Figure 10: Global Macro Hedge Fund Performance as of June 2024, Source: Stone Mountain Capital Research, August 2024 Cryptocurrencies have shown a strong performance in 2024. The sector's main benchmark, Bitcoin, returned just under 50% at the end of June 2024. With the recent sell-off, cryptocurrency hedge funds are likely to take a hit when the August figures are released. Nevertheless, the industry has still delivered a great performance, even taking this drawdown into account. As of June 2024, our cryptocurrency strategies returned an average of 57%, with the most successful strategies returning 150%. Figure 11 shows a comparison of our Cryptocurrency Strategy Index with various benchmarks. Although cryptocurrencies are a new asset class and the number of cryptocurrency-focused hedge funds is increasing, we are seeing more and more unique strategies. These can range from dedicated sub-industries (e.g. decentralised finance or collateralised lending), different stages (fully liquid tokens or early stage tokens) and a variety of strategies in handling the underlying, e.g. long-only or long-short approaches. A more detailed look at cryptocurrencies can be found in a later section of the report. Figure 11: Cryptocurrency Strategy Index Performance as of June 2024, Source: Stone Mountain Capital Research, August 2024 Funds of hedge funds (FoHFs) also had a solid start to 2024. FoHFs returned around 5%-7%, depending on the benchmark used. Our FoHF strategy index returned 5%, while our equally weighted hedge fund indices returned around 20%, as shown in Figure 12. The strategy is typically attractive in a difficult environment due to its high degree of diversification. As markets have almost only gone up across asset classes, investor interest in the strategy is limited. However, should current concerns materialise and a crisis loom, FoHFs offer an excellent option to manage downside. Figure 12: Fund of Hedge Funds Strategy Index Performance as of June 2024, Source: Stone Mountain Capital Research, August 2024 Private Equity & Venture Capital H1 Summary The private equity industry has been in a difficult state for the past two years. The ecosystem is not favourable to the industry. During the pandemic, valuations increased tremendously, which led most companies to raise money at these high valuations. As a result, many companies do not need new capital at this time, and the low valuations compared to a few years ago further discourage new rounds. In addition to their direct impact on company valuations, high inflation and high interest rates have also led to a slowdown in economic activity. Private equity exits in the first half of 2024 totalled $153bn globally, 26% lower than in the first half of 2024. This is notable as the previous year was not great for the industry either. This puts additional pressure on the industry as investors demand a return on their capital, which is problematic due to low exits. The longer this ecosystem persists, the more difficult it will be as the exit value will fall as buyers are aware of the difficulties sellers are facing. This is exacerbated by the current low valuations in general. This slowdown is reflected in total exit values. In 2023, exit values fell below $600 billion, the lowest level in almost a decade. The decline is particularly steep considering that more than $1.6tn of capital was moved through exits in 2021. In 2024, private equity dry powder rose to a new record level of $2.6tn. However, compared to 2023, dry powder only grew by $60bn, having only grown by $30bn in 2023. Although dry powder is growing, the small increase over the last two years shows the industry's struggles. Figure 13 shows the evolution of private equity dry powder since 2000. As is often the case, the industry consolidates in difficult times, with the majority of funds going to established funds. This follows the notion that established managers have weathered previous crises, allowing them to navigate these more challenging ecosystems. While the macroeconomic ecosystem is not favourable, the problem with capital deployment is the lack of available opportunities at attractive prices. It is unlikely that this situation will be resolved in the short term, but as soon as the M&A and IPO market picks up pace, the private equity industry will strongly benefit from it. Figure 13: Global Private Equity Dry Powder in Billion USD from 2000 to July 2024, Source: S&P Global & Preqin, August 2024 Fundraising shows a more promising picture for the industry. The industry managed to raise $550 billion in 2023. Unlike most other key indicators, fundraising was up slightly on 2022 and, more importantly, only $100bn less than the record year of 2021. However, the industry's current problems are clearly reflected in the number of funds raising capital. In 2023, just over 500 funds raised capital, compared to over 1,500 in 2021 and 1,200 in 2022. The venture capital space has been hit harder than private equity due to its higher risk, which has not been favourable to investors. The limited number of deals available, a challenging macroeconomic ecosystem and falling valuations are the main reasons for this. According to GlobalData, total deal value in the US reached $61bn in H1 2024. While this is only slightly below the $65bn recorded in H1 2023, it is well below the deal activity recorded in 2021/22, when the industry experienced record growth. The headwinds for the industry are also evident in the venture capital space, where the number of deals has fallen by almost 50%. The declining number of deals also highlights a focus on larger deals. A key driver is certainly artificial intelligence. In 2023, most of the rounds were early stage, and valuations have only continued to increase. There have been several billion-dollar deals, with X.AI leading the way with its latest $6 billion round. Due to the challenging ecosystem, venture capital fundraising also took a significant hit. In the first half of 2024, the venture capital industry collectively raised $49bn, bringing the current level of fundraising to similar pre-pandemic levels of around $100bn for the full year. The explosive growth in venture capital occurred in 2021/22, when $190bn and $170bn were raised respectively. Since then, levels have fallen significantly and continue to fall, as shown in Figure 14. While it was expected that the industry could not sustain such steep growth, an eventual return to normal levels was expected. This should also help the industry to recover, as valuations are also falling. Barring any other major negative events, it is unlikely that activity and fundraising in the sector will decline further. Historically, these are periods that age very well and should lead to renewed interest in the space. Figure 14: Global Venture Capital Fundraising and Number of Funds Closed from 2019 to H1 2024, Source: Venture Capital Journal, August 2024 Blockchain / Cryptocurrencies H1 Summary The cryptocurrency market has had an impressive 2024 so far. In particular, the beginning of the year saw prices soar following the approval of the spot Bitcoin (BTC) ETF. Bitcoin started the year at $42,000 and soared to over $70,000 by March 2024. Prices have never surpassed those levels. Ahead of the halving, BTC briefly fell below $50k, but quickly recovered on the surprise approval of the Spot Ethereum (ETH) ETF. Cryptocurrencies then fell in value, culminating in the global sell-off in early August, when Bitcoin briefly fell below $50k. However, cryptocurrencies have bounced back and Bitcoin is now back at $60k. Unsurprisingly, ETH has moved in tandem with BTC, but has been less successful overall than BTC this year. Over the past year, ETH has risen by 30%, while BTC has risen by almost 100%. This growth has also translated into a soaring market capitalisation for the entire cryptocurrency market. By the end of 2023, cryptocurrencies collectively totalled around $1.1 trillion, which grew to $1.8tn by the time the Spot BTC ETF was approved, and soared to $2.7tn by March 2024. These heights mark the peak of cryptocurrencies in 2024. At the time of writing, the market capitalisation of cryptocurrencies hovers between $2tn and $2.1tn, as shown in Figure 15. Figure 15: Total Market Capitalisation of Cryptocurrencies & Indexed Performance of Bitcoin and Ethereum Since July 2023, Source: CoinMarketCap, August 2024 The stablecoin market in the cryptocurrency space is also growing steadily. In particular, Tether is doing very well and currently accounts for around 70% of the total market cap of stablecoins. At the time of writing, Tether (USDT) is managing $116 billion. Tether's success is also particularly notable when you compare its figures to those of major banks. Tether recorded a profit of $5.2 billion, which is comparable to the profits of the world's largest banks. This revenue puts Tether in sixth place, as shown in Figure 16. What is even more remarkable is that Tether achieved these results with only 100 employees, compared to the 80,000 to 240,000 employees of the banks with higher revenues. Specifically, Tether earns $52 million per employee, while Goldman Sachs earns $160,000 per employee, which is far higher than any other bank. As Tether is a stablecoin and based on the US dollar, the company holds nearly $100 billion in US dollars. This places it firmly in the top 20 holders of US dollars. It is also notable that Tether is a fiat backed stablecoin, which is the dominant type of stablecoin, as other approaches, especially algorithmic stablecoins, have failed spectacularly in the past. Figure 16: H1 2024 Earnings in Billion USD of the Largest Bank and Tether, Source: Fintech Blueprint, August 2024 Private Debt H1 Summary The private debt industry is in great shape. The current ecosystem makes the asset class extremely appealing to investors. More specifically, there are several characteristics that are attractive to investors. Firstly, the asset class is relatively safe and offers a great risk-reward profile. This is because most of the industry's debt is based on floating rates, resulting in strong yields following the steep interest rate rises of recent years. Floating rates also add safety as they can act as a hedge against higher inflation expectations, rising interest rates and generally more aggressive central bank monetary policies. The asset class is also highly resilient in turbulent markets due to its focus on quality. This also results in low valuation uncertainty and low exposure to market volatility. While attractive yields can now be achieved in the public market through fixed or floating rate securities, private markets offer additional risk premia. Secondly, the ecosystem is highly attractive for the asset class. Over the past three years, the focus on floating rates has allowed the asset class to avoid much of the drawdown experienced by other fixed income assets. Particularly now, with policy rates high and inflation moderate, real yields are appealing. This ecosystem is likely to prevail for an extended period, and private debt is ideally positioned to capitalise on this. Finally, it is also an important component for private companies nowadays. Before the financial crisis of 2008/09, companies relied entirely on bank lending, but this is no longer the case. While bank financing remains the most common source of debt, private debt, and in particular direct lending, is a viable alternative. Banks have become more reluctant to lend, which has allowed private debt to grow to the extent it has. Banks have to take into account increased macroeconomic risks, greater regulatory scrutiny and the turbulence caused by the recent banking crisis. The private debt industry manages a total of $1.6 trillion in capital as of 2023 data. Over the past two years, the industry has grown more slowly than before. However, the industry is still growing rapidly, with an annual growth rate of 13.5% since 2006. In 2023, the growth of AuM of private debt has slowed, which is likely due to a general shortage in the alternatives space. However, prior to 2023, the private debt experienced steady growth since 2015, as shown in Figure 17. The industry now accounts for around 15% of debt of private companies and has become more important recently. The need for private debt has increased due to the aforementioned reluctance of banks, the growth of private equity, which is increasingly using private debt in its deals, and increased investor growth. Its recent growth has also allowed the asset class to rival leveraged loans and high yield corporate bonds in terms of outstanding volume. The impressive growth has also been seen in the middle market, where private debt is most prevalent. In particular, large deals have soared since the pandemic, when only a few deals per year exceeded $1 billion, compared to 50 deals per year since 2021. Borrowers find private debt attractive not only because of the difficulties in obtaining bank loans, but also because of its flexibility in structuring deals and a typically simpler origination process compared to bank loans or the public credit market. Figure 17: Total Private Debt AuM by Dry Powder and Invested Capital and Continuous Annual Growth Rate (CAGR) of AuM Since 2006, Sources: Pitchbook, August 2024 Private debt continues to raise solid amounts of capital, while most other alternative asset classes see their fundraising fall sharply. In 2023, the industry raised nearly $200bn. This is in line with fundraising activity from 2017 to 2020, and slightly lower than in 2021 and 2022. In its record year, the industry raised almost $300 billion. Figure 18 shows capital raised by strategy since 2006. Recently, there has been a shift in the favoured strategy. Historically, direct lending has been the dominant strategy in the sector, accounting for nearly 50% of total private debt assets. Direct lending was also a key reason for the huge success of private debt in 2021. More recently, riskier strategies have caught the attention of investors. In 2023, direct lending raised 32% of capital, compared to 19% for mezzanine, 15% for special situations and 11% for distressed debt. Figure 18: Total Private Debt Fundraising & Fundraising by Strategy from 2006 to 2023, Source: Pitchbook, August 2024 Although direct lending remains the largest portion of private debt, which is the least risky strategy within private debt, the asset class has impressed recently with its safe profile. Compared to US investment grade and high yield default rates, private credit has had a significantly lower default rate than public credit. In the last two quarters, private credit default rates fell below 2%, while public default rates rose above 3%. Figure 19 shows the evolution of default rates in the public and private credit markets since 2020. While the asset class is currently in good shape, especially during the early stages of the pandemic, private credit has overtaken high yield default rates. Figure 19: Default Rates of Private and Public Corporate Credit from 2020 to Q4 2023, Sources: Allianz Research & Proskauer Private Credit Default Index, August 2024 With the attractive low risk of the asset class highlighted, a detailed look at performance is crucial. Private debt has delivered attractive returns in recent years, with a relatively low risk profile. On a quarterly average, the private debt industry has returned 8% per annum since 2017, and the industry as a whole has not had a negative quarter, even during the pandemic. Riskier strategies such as mezzanine and special situations occasionally had a negative quarter, but compensated strongly after the pandemic when the strategy bounced back impressively. Direct lending also returned an impressive 7% with low risk. Particularly when compared to public credit, direct lending has delivered steady returns. Since 2017, direct lending has almost doubled, while public credit has only increased by around 10%, as shown in Figure 20. Figure 20: One-Year Rolling IRRs of Private Debt Strategies & Cumulative Performance of Direct Lending Compared to US IG Corporate Bonds, Sources: Pitchbook, Cliffwater, Bank of America, Merrill Lynch, August 2024 Real Estate H1 Summary The real estate sector remains in a difficult position. Historically, inflation has put pressure on property returns, which have struggled to be positive when inflation is taken into account. Although inflation has come down significantly, property returns are more attractive again. However, high interest rates continue to cause problems for the sector, especially given that interest rate cuts are taking much longer than originally expected. This is leading to much higher mortgage rates and therefore much higher property costs. This has led to uncertainty about valuations and lower transaction volumes. With valuations now falling, sellers are reluctant to sell, while buyers are planning to buy at a later stage when valuations are likely to fall further. This mismatch in pricing is also contributing to the low level of deal activity in the sector. Other challenges in the industry have also contributed to reduced activity. Idiosyncratic issues such as the property crisis in China and the property crisis in Germany are also contributing. While these problems do not apply to the property market as a whole, they send a worrying signal to the market as a whole and to potential investors. An additional headwind comes from the recent regional banking crisis. As a result, bank lending has been significantly tightened in order to reduce the risk of another, potentially more severe, banking crisis. This trend is likely to continue, even if interest rates are cut. While private lenders are helping to alleviate this problem, private lenders cannot cover the same amount that has been lost through reduced bank activity. This can be seen in the M&A activity of US REITs. There was only one deal in the first half of 2024, compared with four in the first half of the previous year and eight in 2023. Of course, the total deal volume is quite low, even though the one deal is a large one. Figure 21 shows the historical development and the difficulties the industry is currently facing. Figure 21: Real Estate M&A Deal Agreements Involving Public Equity REITs by Quarter Since Q1 2017, Source: S&P Global Market Intelligence, August 2024 While the industry as a whole is facing challenges, some strategies are still in good shape and growing steadily, while others are being hit harder by the current crisis. Commercial real estate has not been in good shape since the shift in work dynamics following the pandemic and the increasing trend towards working from home. Since then, commercial property delinquencies have been on the rise, especially for offices. This is also reflected in office REITs, which are trading at the largest discount to their NAV compared to other REIT strategies. On the other hand, there has been increased interest in specialist properties. This is particularly the case for decarbonisation and data centres, which are benefiting from ongoing trends and increased government support. Since the pandemic, manufacturing facilities and logistics have also benefited from strong concerns about global supply chains. 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). In private assets, we advise 10+ sponsors and general partners across private equity, venture capital, private credit, real estate, capital relief trades (CRT) by structuring funding vehicles, rating advisory and private placements. As of 2nd February 2024, Stone Mountain Capital has total alternative Assets under Advisory (AuA) of US$ 62.4 billion. US$ 48.5 billion is mandated in hedge funds and US$ 13.9 billion in private assets and corporate finance (private equity, venture capital, private debt, real estate, fintech). 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