ALTERNATIVE MARKETS UPDATE - ALTERNATIVE MARKETS OUTLOOK 2023

Inflation was a core issue in 2022 and remains to be one in 2023. In the US, inflation started to decline in the summer of 2022 and remains currently at a level of 7.1%. Contrarily, in Europe and the UK, inflation remains a huge issue and has barely declined from its peak in 2022. It remains at 11.1% for the EU and at 10.7% for the UK. The difference between the inflation can largely be attributed to two factors. Firstly, the Fed hikes interest rates more aggressively than its European counterparts. This led to a quicker response to inflation. Secondly, Europe is more directly affected by the war between Russia and Ukraine and is largely dependent on Russian oil and gas, which soared in price following the war. Contrarily to other European countries, Switzerland managed to keep inflation relatively low with a peak in late summer 2022 at 3.5% and 3% currently. Switzerland managed to avoid high inflation due to its strong currency and relatively low demand for fossil fuels, as most of its electricity stems from hydropower and nuclear power. In Asia, both Japan and China also experience limited inflation issues. Japan achieved this through its central bank which continuously intervenes with large-scale monetary easing. Despite the low inflation, Japan is still suffering, as wages remain stagnant unlike in other major economies where it helps offset the higher inflation to some degree. China does not face an inflation problem, due to their different handling of the Covid crisis. Unlike most economies, they did not provide large stimuli to the economy. Additionally, their zero-Covid policy substantially reduced household demands. Figure 1 shows a summary of the inflation rates across the highlighted economies during 2022. Regarding 2023, it is widely expected that inflation, especially in high-inflation countries, will come down. For instance, in the US, it is expected that inflation will be around 4% on average, and close to the 2% Fed target by the end of the year. Inflation forecasts in the EU and the UK are more difficult to estimate, due to their dependency on the war and its outcome. Additionally, unlike in the US, inflation has not really started to decrease. Assuming further strong interventions by the European central banks, it is expected that inflation will drop substantially. The ECB expects the average inflation to be around 5%-6% during 2023 with inflation slightly below 4% by the end of 2023. In the short term, Europe will be under pressure and the measures take time to become effective, as shown in the example of the US. Despite a similar outlook to the US, albeit with a delay of around half a year, it is less promising. One important wildcard is energy prices, which are strongly linked to the war. While the EU managed to get its oil largely from other sources than Russia, it still needs Russia, and gas is not as easily substitutable. With the prospect of Russia’s supply cut and China reopening, prices of energy sources are likely to increase. Depending on the scale, if it occurs, the anticipated target may not be reached and inflation will remain higher than the target. In Switzerland, inflation is expected to remain around the 3% mark for 2023. Given the strong involvement of the BoJ, Japan’s inflation is expected to end the year 2023 below the 2% inflation mark. It is additionally expected that wages will rise for the first time in three decades. Inflation in China is expected to rise to around 2% in 2023. This is a combination of the reopening of the economy and the end of the zero-Covid policy. This will lead to an increase in economic activity and the necessity for further energy. Additionally, the price pressure across will also be felt in China, once demand picks up again. The interest rate hikes by most countries have been another crucial topic during 2022. So far, the hikes have shown limited effectiveness in dealing with soaring inflation. In high-inflation countries, it was effective for the US and had little impact on the European countries. However, this discrepancy is likely due to the steeper hikes in the US and less dependency on the war by the US. The US employed the strongest measures, as it hiked from 0% at the beginning of 2022 to 4.25% at the end of 2022. In contrast, the ECB just started hiking in June 2022 at -0.5%, which increased to 2% by the end of 2022. The BoE employed a mixture of the two. The UK started hiking at the end of 2021 but hiked in smaller steps than the US. Towards the end of 2022, it increased the step size and is currently at 3.5%. Switzerland started hiking earlier than the ECB, despite substantially lower inflation. Switzerland’s prime rate became positive for the first time in years in September 2022. Currently, the prime rate is sitting at 1%. Japan was one of the exceptions, as the BoJ did not hike at all. Its prime rate remains at -0.1%. However, the central bank still strongly intervened in the market as elaborated previously. The People’s Bank of China even lowered its prime lending rate over 2022, albeit to a minimal degree. Currently, the rate is at 3.65%. There is a strong consensus for the year 2023 in the US and Japanese markets. Most market participants expect the Fed to keep raising interest rates to around 5%-5.25%. The Fed is likely to do this in smaller steps than previously. Nonetheless, this level should be reached by the end of Q1 2023. Afterward, a majority of institutions do not expect further hikes or cuts in 2023. The remainder anticipates potential interest rate cuts in Q4 2023. The exact outcome of potentially further hikes or cuts largely depends on the state of the US economy in the latter part of 2023. While the measures seem to be effective and inflation is going down considerably, the risk of a recession is considerable. This largely stems from substantially higher financing costs for businesses, and lower demand from consumers as Covid reserves are exhausted and households feel the pressure from the inflation over the past year. Given that the BoJ has not intervened by raising interest rates, it is not expected that it will in 2023. It is more likely that it will continue its qualitative and quantitative easing philosophy employed so far. In particular, as Japan does not face an imminent inflation problem. With expected wages adjusted, the pressure of inflation should also be eased without a strong necessity to make policy adjustments. For the EU, it is expected that rates will be hiked further to combat the prevalent inflation. Market participants expect interest rates of around 3%, which should be reached during Q2 2023. For the UK, additional hikes of 1% are expected, resulting in interest rates of around 4.5% for 2023. For both economies, no rate cuts are expected in the latter half of 2023. In Switzerland, the SNB is anticipated to hike another 0.5% in 2023 with no rate cuts as well. ​

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RESEARCH PERSPECTIVE VOL. 194 December 2022 Alternative Markets Outlook 2023 Inflation was a core issue in 2022 and remains to be one in 2023. In the US, inflation started to decline in the summer of 2022 and remains currently at a level of 7.1%. Contrarily, in Europe and the UK, inflation remains a huge issue and has barely declined from its peak in 2022. It remains at 11.1% for the EU and at 10.7% for the UK. The difference between the inflation can largely be attributed to two factors. Firstly, the Fed hikes interest rates more aggressively than its European counterparts. This led to a quicker response to inflation. Secondly, Europe is more directly affected by the war between Russia and Ukraine and is largely dependent on Russian oil and gas, which soared in price following the war. Contrarily to other European countries, Switzerland managed to keep inflation relatively low with a peak in late summer 2022 at 3.5% and 3% currently. Switzerland managed to avoid high inflation due to its strong currency and relatively low demand for fossil fuels, as most of its electricity stems from hydropower and nuclear power. In Asia, both Japan and China also experience limited inflation issues. Japan achieved this through its central bank which continuously intervenes with large-scale monetary easing. Despite the low inflation, Japan is still suffering, as wages remain stagnant unlike in other major economies where it helps offset the higher inflation to some degree. China does not face an inflation problem, due to their different handling of the Covid crisis. Unlike most economies, they did not provide large stimuli to the economy. Additionally, their zero-Covid policy substantially reduced household demands. Figure 1 shows a summary of the inflation rates across the highlighted economies during 2022. Regarding 2023, it is widely expected that inflation, especially in high-inflation countries, will come down. For instance, in the US, it is expected that inflation will be around 4% on average, and close to the 2% Fed target by the end of the year. Inflation forecasts in the EU and the UK are more difficult to estimate, due to their dependency on the war and its outcome. Additionally, unlike in the US, inflation has not really started to decrease. Assuming further strong interventions by the European central banks, it is expected that inflation will drop substantially. The ECB expects the average inflation to be around 5%-6% during 2023 with inflation slightly below 4% by the end of 2023. In the short term, Europe will be under pressure and the measures take time to become effective, as shown in the example of the US. Despite a similar outlook to the US, albeit with a delay of around half a year, it is less promising. One important wildcard is energy prices, which are strongly linked to the war. While the EU managed to get its oil largely from other sources than Russia, it still needs Russia, and gas is not as easily substitutable. With the prospect of Russia’s supply cut and China reopening, prices of energy sources are likely to increase. Depending on the scale, if it occurs, the anticipated target may not be reached and inflation will remain higher than the target. In Switzerland, inflation is expected to remain around the 3% mark for 2023. Given the strong involvement of the BoJ, Japan’s inflation is expected to end the year 2023 below the 2% inflation mark. It is additionally expected that wages will rise for the first time in three decades. Inflation in China is expected to rise to around 2% in 2023. This is a combination of the reopening of the economy and the end of the zero-Covid policy. This will lead to an increase in economic activity and the necessity for further energy. Additionally, the price pressure across will also be felt in China, once demand picks up again. The interest rate hikes by most countries have been another crucial topic during 2022. So far, the hikes have shown limited effectiveness in dealing with soaring inflation. In high-inflation countries, it was effective for the US and had little impact on the European countries. However, this discrepancy is likely due to the steeper hikes in the US and less dependency on the war by the US. The US employed the strongest measures, as it hiked from 0% at the beginning of 2022 to 4.25% at the end of 2022. In contrast, the ECB just started hiking in June 2022 at -0.5%, which increased to 2% by the end of 2022. The BoE employed a mixture of the two. The UK started hiking at the end of 2021 but hiked in smaller steps than the US. Towards the end of 2022, it increased the step size and is currently at 3.5%. Switzerland started hiking earlier than the ECB, despite substantially lower inflation. Switzerland’s prime rate became positive for the first time in years in September 2022. Currently, the prime rate is sitting at 1%. Japan was one of the exceptions, as the BoJ did not hike at all. Its prime rate remains at -0.1%. However, the central bank still strongly intervened in the market as elaborated previously. The People’s Bank of China even lowered its prime lending rate over 2022, albeit to a minimal degree. Currently, the rate is at 3.65%. There is a strong consensus for the year 2023 in the US and Japanese markets. Most market participants expect the Fed to keep raising interest rates to around 5%-5.25%. The Fed is likely to do this in smaller steps than previously. Nonetheless, this level should be reached by the end of Q1 2023. Afterward, a majority of institutions do not expect further hikes or cuts in 2023. The remainder anticipates potential interest rate cuts in Q4 2023. The exact outcome of potentially further hikes or cuts largely depends on the state of the US economy in the latter part of 2023. While the measures seem to be effective and inflation is going down considerably, the risk of a recession is considerable. This largely stems from substantially higher financing costs for businesses, and lower demand from consumers as Covid reserves are exhausted and households feel the pressure from the inflation over the past year. Given that the BoJ has not intervened by raising interest rates, it is not expected that it will in 2023. It is more likely that it will continue its qualitative and quantitative easing philosophy employed so far. In particular, as Japan does not face an imminent inflation problem. With expected wages adjusted, the pressure of inflation should also be eased without a strong necessity to make policy adjustments. For the EU, it is expected that rates will be hiked further to combat the prevalent inflation. Market participants expect interest rates of around 3%, which should be reached during Q2 2023. For the UK, additional hikes of 1% are expected, resulting in interest rates of around 4.5% for 2023. For both economies, no rate cuts are expected in the latter half of 2023. In Switzerland, the SNB is anticipated to hike another 0.5% in 2023 with no rate cuts as well. With the exception of low chances of rate cuts in 2023, the interventions seem conservative. Compared to the US, which seems to have inflation under control now, this does not hold for European countries. However, they cannot hike that aggressively as the recession risk is substantially higher. The continuous interest rate hikes led to one of the worst years for government bonds. Figure 3 shows an example of UK government bond returns. In 2022, government bond rates also saw frequent yield curve inversions, which are commonly used as recession indicators. Especially in the US, the yield curve inversion is steep and has persisted over a long time. Figure 4 summarizes the yield curve inversions of 2- and 10-year government bonds in the US, UK, Switzerland, and Germany. Figure 1: Inflation Rates in Percentage in the US, EU, UK, Switzerland, Japan, and China During 2022, Sources: Board of Governors of the Federal Reserve System (US), Eurostats (EU), Office for National Statistics (UK), Swiss Federal Statistical Office (CH), Ministry of Internal Affairs & Communication (JP), National Bureau of Statistics of China (CN), December 2022 Figure 2: Interest Rates by the Federal Reserve (Fed), European Central Bank (ECB), Bank of England (BoE), Swiss National Bank (SNB), Bank of Japan (BoJ), and the People’s Bank of China (PBoC) during 2022, Sources: Federal Reserve, ECB, BoE, SNB, BoJ, PBoC, December 2022 Figure 3: Annual Government Bond Returns Since 1700 in the UK (*: annualized as of October 2022), Sources: BofA Global Investment Strategy, GDF Finaeon, December 2022 Figure 4: 2-Year and 10-Year Government Bond Returns in the US, UK, Switzerland, and Germany in 2022, Source: Investing, December 2022 At this point, a recession is highly likely and anticipated by most market participants. However, the big questions are when and to what extent. A recession in Europe is expected to occur first, given their strong dependency on the war. Additionally, Europe is still facing high inflation, which will affect consumer spending and reduce company earnings. In some instances, a recession is forecasted this winter and most others expect it to occur later in 2023. Nonetheless, an early recession in 2023 in the EU is somewhat revoked, as Europe dealt surprisingly well with the energy crisis, as 80% of oil is now exported outside of Russia, and gas reserves are higher than anticipated. In the US, a recession is likely to happen towards the end of 2023 or in 2024. This can largely be traced back to the exhausted Covid reserve of households and the inflation in the past 1.5 years. Again, this leads to reduced consumer spending and thereby less revenue for companies combined with high financing costs due to the interest rate hikes in the past year. The housing market in the US is also facing pressure, as mortgage rates have become exceedingly expensive, which led to a massive slowdown in construction alongside a substantial decline in housing prices. This development is notable, as the housing sector makes up 3% of the US GDP. In line with a reasonable risk of a recession ahead, the global growth for the entire world is estimated to be around 1.5%-2%, which would be the lowest global growth excluding the global financial crisis in 2007/08 and the Covid-19 year. While the growth of the US and Europe is largely dependent on whether a recession occurs, it is still expected that the two economies will be close to flat in terms of growth. Europe has the tendency to contract slightly, while the US is expected to grow slightly. The main contributor to global growth in 2023 is stemming from China, in which a growth of around 4% is expected. This growth will largely stem from the opening of the economy and the initial boom from it. Figure 5 summarizes the growth and inflation expectations. Figure 5: Actual & Forecasted Real GDP (Left) and Inflation (Right) in 2021, 2022, and 2023: Source: Pictet Wealth Management, November 2022 Gold had an unspectacular year in 2022. It started and ended the year at $1,800 per ounce. During 2022, it peaked in March at $2,050 when the war started and bottomed at $1,625 from October to November. Gold’s outlook for 2023 is mixed with slightly more upside potential than downside potential in the longer term. Firstly, gold does well historically during recessions, as it functions as a safe haven asset. Additionally, the perception that Bitcoin is an alternative safe haven asset did not hold during Covid-19. Hence, in the next crisis gold can expect more inflows than when Covid-19 emerged. Figure 6 summarizes the historical performance of gold during recessions. The recent strength of the USD is also a positive indicator of gold. In particular, as the USD has lost a substantial part of its gains in the past two years. The pressure on the USD is likely to increase, as other countries will increase their interest rates and lower pressure on the Euro, once energy prices are stabilizing. Gold also fares well in situations with elevated geopolitical risk, which is certainly given currently. In 2022, the gold price was substantially disconnected from its underlying price drivers. Once inflation is steadily decreasing, and rates are no longer raised, gold’s fundamental drivers suggest an even higher price. The major indicator for declining gold prices is the increasing interest rates, which increase the opportunity costs of holding gold. While the declining inflation helps gold, it is expected that interest rates will increase in 2023 and remain at these levels for the time being. Figure 6: (LBMA) Gold Price During Recessions Indexed to Start of Recession, Sources: Bloomberg, ICE Benchmark Administration, NBER, World Gold Council, GoldHub, December 2022 Lastly, oil had a specular year in 2022. While the performance of oil is flat in 2022, it had a strong bull run when the war started. WTI crude reached heights of $120 per barrel. Since June 2022, oil is continuously declining in value, as the European countries started to manage their relations with Russia and its oil and gas. Additionally, the OPEC+ and the US strongly intervene to address the energy crisis. In 2023, oil is expected to increase in value. Various forecasts see oil averaging a price of $90 per barrel with a peak of around $110 per barrel. Significant factors include the necessity for oil in Europe that preferably should not stem from Russia, and a low likelihood of the OPEC+ to drastically increasing outputs. Moreover, oil demand from China is expected to increase following the re-opening of the economy as well as further potential supply cuts from Russia. Hedge Funds Hedge funds faced a difficult year in 2022. After an overall great 2020 and 2021, when they could offer downside protection and profit from soaring markets, 2022 is likely to become the worst year in a decade. In an ecosystem of high volatility and most asset classes incurring losses, hedge funds had difficulties generating performance. This led to net outflows and negative performance that brought its AuM down from its heights during 2021. At least at the beginning of 2023, this trend is likely to continue. Once inflation is under control and continuously falling, rates are likely to plateau, which should increase the stability of financial markets, hedge funds should be positioned more comfortably. After this initially difficult position in the short term, the industry is expected to grow further. Preqin estimates that the industry should grow to $5tn by the end of 2027, compared to its $4.1tn as of Q2 2022. They expect a growth rate similar to those pre-Covid after the current drawdown. In early 2023, it is expected that the current winner strategies should persist. These include dedicated downside protection strategies, CTAs, global macro, and relative value strategies. These strategies are positioned best to minimize drawdowns in single markets and profit from arising discretionary opportunities. Multistrategy, fixed income, and equity hedge funds will face a harsh ecosystem in the short term. While the end of this unfavorable ecosystem will end sooner for fixed income strategies, equity hedge funds will be under a lot of pressure well into 2024. With a significant chance of a recession ahead (mostly anticipated in late 2023 and early 2024), equity hedge funds will have to prove their ability to manage drawdowns once again. In 2020 and 2021, market participants were satisfied with the management of hedge funds. However, 2022 was disappointing in this regard. This certainly contributed to the wave of redemptions hedge funds experienced in 2022. While the outlook for 2023 does not look bad for the industry as a whole, the latter strategies will face problems. Unfortunately for the industry, a vast majority of hedge funds pursue equity strategies, which suffer the most and are likely contributors to sub-par years ahead. The industry will also focus more and more on the US, at the expense of European funds and funds from Asia. The aforementioned difficulties currently and ahead also led to outflows, which can be devastating for smaller funds. Smaller funds will be under even more pressure, as 2022 was a year, in which the big funds substantially outperformed smaller funds. In conjunction with a general consolidation trend, frequently observed in contracting markets, smaller funds have to become innovative to stay alive. It is also expected that further capital will be pumped into the industry, once rates and inflation have stabilized. One advantage over, more stale, private markets are that they mostly deal in public markets. This also leads to a faster correction of prices and does not lead to an over-allocation in hedge funds by institutional investors. Private Equity In the last two years, the private equity industry enjoyed an ideal ecosystem. This beneficial tailwind subsided in early 2022 with high inflation, soaring interest rates, and a crashing equity market. While inflation is declining, the remaining factors remain well intact in 2023 and possibly in 2024. The private equity industry is also subject to the issues the public equity market is facing with lower consumer demand and therefore fewer earnings. This alongside the drop in the value of public equity leads to a drop in the valuation of private companies as well, albeit with a delay. This leads to several challenges ahead for the private equity industry, at least in the short term. Firstly, due to the interest rate hikes, financing and costs of leverage become more expensive. Aside from the general negative impact on growth, it could also lead to distress in companies, especially if floating rates are not hedged. This is further exacerbated by the lower expected revenues in 2023. Secondly, valuation gaps will lead to a lower number of deals in the short run. Buyers are now very cautious with their investments, while sellers do not want to sell at the (now) lower prices. This mostly applies to Western countries. In Asia, it is not necessarily a problem, as the country-specific drivers are more important there. In China, dealmaking is likely even more difficult given their current property crisis and a high degree of uncertainty with the regime switch regarding their zero-Covid policy. Thirdly, there are now more opportunity costs involved with private equity investments. Not only is the scale of contraction unknown yet but with the rising rates, bonds and in particular private debt become solid and more defensive alternatives. Despite the currently difficult ecosystem, it is expected that the private equity industry will grow further in 2023, albeit at a slower pace. Currently, the AuM of the industry is around $4.1tn. Preqin estimated that the industry’s AuM will rise to slightly below $8tn by the end of 2027. They argue that growth in the short term will be held back substantially but will continue to grow at a rate similar to the pre-pandemic levels. Figure 7 shows the historical growth of the industry and its forecasted growth until the end of 2027. Fundraising in the industry will be difficult in 2023, especially early in the year. Many reasons are the aforementioned challenges the industry faces in the short term. However, another key reason for the decline in anticipated funds is related to the allocation caps institutional investors are subject to. With the substantial decline in public markets, their private equity portion is valued higher relatively, as private market returns are lagged. Thus, institutional investors may be close to their cap or are over-allocated to the private equity industry. This leads to a legal limitation on how much they can allocate to private equity in the next year. The industry is already experiencing a significant slowdown in fundraising. Comparing Q3 in 2021 and 2022, in 2022 fundraising dropped by 16% leading to 30% less fund closing than in the prior year. While this is a notable decline, historically, the current fundraising levels are still very strong. In 2023, it is likely that fundraising will go down further. Another reason for further declines is that the overall risk tolerance has substantially declined over the past year. This stance will also be crucial in 2023 and possibly 2024, especially if a recession occurs during this time. Similarly to a decline in fundraising, deal activity also slowed. As of Q3 2022, the number of deals compared to 2021 is down by 18% but the total value of those deals is only 50% of the value in 2022. Although this is a steep decline, this is still on the same levels ahead of Covid-19. Despite the rather negative overall view of the industry, there are several positive factors in the industry in 2023. Firstly, private equity tends to do substantially better than public equities in crises. The industry typically reacts later to changing prices but the decline in value is mostly lower. Additionally, after crises, private equity returns tend to be the highest. Figure 8 shows a comparison of the performance of private equity vs. global equities with a focus on performance during crises. Although public equities corrected substantially, while private equity has not, the entry multiples historically are still superior to public equity. Secondly, the industry is still sitting on a considerable amount of dry powder. Although there is a current mismatch between the expected price from buyers and sellers, this is somewhat mitigated by a large amount of outstanding dry powder. As funds prefer not to sit on available capital too long, this capital needs to be deployed and softens the declining valuations. Moreover, after the initial crisis is over, there will be a substantial number of attractive deals in the market. Lastly, secondaries are likely to become more important in the coming year. In a crisis, it is more likely that there are capital shortages from investors or institutional investors that are over-allocated to private equity. This leads to further investment opportunities in the market. Figure 7: Forecasted AuM of Private Equity Separated by Geography until 2027, Source: Preqin, December 2022 Figure 8: Private Equity and Public Index Returns in Tumultuous Markets, Source: BlackRock Alternatives, December 2022 Venture Capital The macroeconomic ecosystem is all but favorable for venture capital. Most issues the private equity industry faces are even more critical for venture capital, as the riskiest sub-class of private equity. The most crucial factors are high interest rates, lower expected revenues, and plummeting equity markets. Importantly, none of these risk factors have reached their peak yet based on the 2023 outlook.  Preqin expects a drop in fundraising and performance for up to five years barring the global equity market should recover quicker than anticipated. Despite this, it is expected that the industry’s AuM will continuously grow. This growth will stem in a large portion due to the higher return of the sector compared to other assets. Performance in the short run will decline substantially, especially after the highly successful previous year. The high AuM growth will be affected by a higher amount of unrealized value, as managers likely will hold onto investment longer than they did the previous two years. Preqin estimates that the AuM of the industry will grow from $1.8tn to $4.2tn at the end of 2027. Nearly $3tn of the expected AuM will be held as unrealized value. Figure 9 summarizes the historical AuM of venture capital as well as the forecasted AuM until 2027. It is also notable that a substantial amount of the current AuM is dry powder, as it accounts for more than $500bn. This current reserve will help alleviate some pressure in the short term as fundraising will be difficult. As previously mentioned, fundraising is already becoming more difficult and this will continue well into 2023 if not 2024 and beyond. With these unfavorable market conditions as well as being the riskiest strategies of private equity investing, the problems will not be solved quickly. According to Preqin, 5,000 funds are raising capital for a total of $400bn. The most prominent strategy is early stage strategies, as the investments usually take a long time before the positions are exited, which gives the strategy more leeway to sit out the crisis. There is also a substantially growing interest in venture debt, as alternative ways of financing are explored under these harsh conditions. In particular, inexperienced managers are having difficulties raising capital, as nearly three-quarters of capital flows into managers with more than three prior funds. When considering that less than half of the target capital has effectively been raised, of which a majority goes to established managers, it highlights the difficult position of emerging managers in the market. The current market ecosystem is also reflected in the current deal volumes. In 2022, 17k deals were conducted compared to $27k deals in 2021. While this is substantially lower, it is still on track to be the second-best year ever. Nonetheless, in terms of value, it decreased from $685bn to only $346bn. This is largely due to fewer deals at lower valuations compared to 2021. It is likely that these figures will not be obtained in the coming year(s). 2023 is very likely not going to be a big year for venture capital but its long-term expectations are still well intact. Additionally, crisis years tend to be very attractive entry points, as those are typically the most profitable years in hindsight. Figure 9: Forecasted AuM of Venture Capital Based on Strategy Until 2027, Source: Preqin, December 2022 Blockchain The cryptocurrency industry faced a tough year in 2022. The industry strongly suffered from the movement towards little-risk assets. While equities already suffered a lot, this goes even further for cryptocurrencies, as they are even riskier, and tend to be the first asset class that gets cut in dire situations. As if this wasn’t enough, two of the largest cryptocurrencies/companies completely collapsed. In both instances, the market took a massive hit. Since then, most currencies regained some of their value but remain close to their lows in 2022. Bitcoin, as the most famous and relatively resilient currency in the space, dropped from $46k at the beginning of 2022 to just above $16k at the end of 2022. Figure 10 summarizes the development of the BTC price in 2022. The aggregate effect on the market is even better shown in the development of the total market capitalization. At the beginning of 2022, cryptocurrencies were worth more than $2.2tn compared to $800bn at the end of the year. In 2023, it is unlikely that the current state of cryptocurrencies in the market will change. With the current tendency to low risk assets, the current high volatility in the market, and a looming recession ahead, it is very likely that cryptocurrencies will continue to lose value in 2023. Although cryptocurrency adoption has substantially increased over the past years, it will not help the industry to a large extent during this time. This can be largely traced back to the fact institutional investors have stepped into the market in the past years. However, in this market ecosystem, institutional investors are not seeking high risk assets, as their outlook is poor and they are likely to negatively contribute to performance in 2023. The rather dire view on cryptocurrencies reflects the general opinion on cryptocurrencies as an industry, and not individual projects and companies. This is especially notable, as cryptocurrency projects built during crises do exceptionally well historically. These highly successful projects fundamentally change issues with underlying technology that is broadly applicable in the industry. One of these changes is the change from proof-of-work (PoW) to proof-of-stake (PoS), in which the consensus algorithm bundle computational power to validate transactions instead of competing with each other. This alleviates energy costs massively. To reiterate the impact of such a change, when Ethereum’s Merge happened in September 2022, Ethereum could reduce its energy usage by around 99.9%. Regarding specific developments in the cryptocurrency industry, it is likely that decentralized finance (DeFi) will continue to grow, especially after the FTX fiasco. Additionally, digital asset exchanges will consolidate, as investors now seek additional safety in their exchanges. Most likely, Binance and Coinbase will be the big winners from these consolidations. The blockchain technology will see further usage, especially in companies. While the blockchain technology has been introduced by various large companies, this development will continue, as companies how it can be applied to various use cases. The last major development will address web3 applications and their ecosystem. Since the latter half of 2022, the number of projects in this area has soared substantially. While non-fungible tokens (NFTs) so far did not live up to their hype in 2021, they are used in very dedicated instances. These mostly include gaming, where they form the economy of games, utility, and identity tokens. Figure 10: Bitcoin Price Development During 2022, Source: CoinMarketCap, December 2022 Fintech The fintech industry will also be under pressure in 2023. The most substantial risk will stem from the elevated interest rates and the substantial possibility of a global recession in 2023/24. The high interest rates lead to high financing costs for companies. Additional capital raises will be also difficult from the equity side, as companies as well as investors are not keen on down rounds. This will lead to financing issues in the short term for the industry. Nonetheless, the impact is also dependent on the sub-strategy. Sub-strategies that directly tackle issues that rose to prominence this year, will be well-positioned in 2023. Such examples are agtech (robotics and smart field equipment) and foodtech. With the food shortages earlier in 2022, companies that focus on the optimization of food supply will be interesting, as they can alleviate further shortages. Pitchbook expects that the industry will see record fundraising in 2023. Similar developments are expected in e-commerce, where a consolidation trend and intensified competition will lead to significant interest in the sector. One of the large winners over the past few years, climate tech will continue to see interest and will likely grow to a new record high, both in fundraising and company values. Across most industries, a wave of consolidations is anticipated. Partially because of the difficult market ecosystem and partially because of elevated levels of interest. For crypto and IoT (internet of things) companies, 2023 will be rough. As mentioned previously, it is widely expected that the crypto industry will see further declines. This translates into VC investments in those companies. Similarly, IoT is less of interest in a phase of heightened market volatility, as the industry does not fundamentally increase the quality of life. The industry rather simplifies life. However, in the current ecosystem, fundamental changes are to be preferred.   Private Debt Out of all the covered asset classes, private debt could be the big winner of this crisis. For the most part, the macroeconomic developments are beneficial to the industry. The current inflation is the major obstacle for the industry, as it reduces the real yields currently obtained. However, at least in the US, inflation is decreasing steadily and it is expected that the other economies will follow. Once inflation is tamed, and rates are high, private debt offers relatively low-risk returns. While the potential issue of a surge in bankruptcies of loans may occur, especially if a recession happens, it can be mitigated by individual funds through thorough deal selection. Conventional private debt strategies enjoy a prosperous macro outlook in 2023. However, more niche strategies, such as opportunistic credit are also well-positioned. Many private companies want to raise further capital but are not too keen on down rounds for equity. They can somewhat mitigate this by issuing dilutive equity rounds, in which credit investors can add additional equity upside. Similarly, distressed debt will be especially interesting if a recession happens. While this is not a requirement in the high interest rate ecosystem, it will boost the strategies with a variety of opportunities. According to Preqin, the AuM of the private debt industry sits at $1.3tn and will likely reach $1.5tn once the final 2022 figures are available. They estimate that the industry reaches $2.3tn by the end of 2027. They reason that current performance and fundraising will slow down compared to their estimates two years ago. Figure 11 shows the estimated growth in AuM of the private debt industry. As of Q3 2022, the industry raised $172bn in capital, and by the end of the year, fundraising will be similarly strong than in 2021. While this is remarkable, in 2022 substantially fewer funds closed than in 2021. Both findings are supported by the survey from Dechert LLP and Mergermarket, who provide further insight into the consolidation trend. Many investors want to remain in the asset class but favor larger allocations to fewer managers. This is supported by the closing of multiple billion-dollar funds, as several direct lending funds closed with more than $6bn each. Preqin finds that the top 10% of funds raised more than 50% of the entire capital raised this year. They also conclude in their survey that nearly two-thirds of investors plan to increase their allocation to private debt. Figure 11: Forecasted AuM of Private Debt Separated by Strategy until 2027, Source: Preqin, December 2022 Real Estate The real estate market is in a difficult situation. While the industry generally provides a stable income stream during market volatility, this is one of the few factors that are beneficial to the industry. Contrarily, the currently high inflation substantially reduces the real performance of the asset class. The soaring interest rates also make mortgages significantly more expensive to the point at which demand for mortgages has dropped considerably. In the case of a recession, the currently steady cash flow is also under pressure. Potentially bankrupting companies, forcing tenants to move out, and less travel. After the industry was put under substantial pressure following Covid-19, the pressure will continue with the current macroeconomic ecosystem. This trend will continue well into 2023 if not 2024 and beyond. Nonetheless, this development did not hit the individual sectors equivalently. The clear winner of the post-pandemic era is industrial real estate. As people could no longer go to shops, online shopping expanded massively and is likely to stay. Additional demand was created due to the supply chain issues that shaped 2022. In 2023, the logistics sector could come under pressure, as consumer spending is expected to go down. This can lead to substantial shortfalls in revenue and threaten a company. The hotel sector has been under pressure since Covid-19 with strong ease in 2022 when traveling was allowed again, and many people felt the urge to compensate for not being able to travel for the past two years. However, with less money available, traveling will slow down and puts the leisure sector under pressure once again. The office sector was put under pressure due to the new “working from home” philosophy after Covid-19. While the economy is again back to normal, working from home is here to stay, at least partially. This leads to the necessity for smaller offices and less revenue for the sector. This issue could be exacerbated in a recession if a lot of layoffs are required. Lastly, residential real estate has done “well” since the pandemic. With the working from home philosophy and fiscal stimulus, people decided to upgrade their homes. Currently, the sector is stable but the looming threat of a recession and tenants no longer being able to afford their housing elevates the risk. Nonetheless, there are niche strategies that build on demographic development and will only be marginally affected by a crisis. These include student housing, childcare, and senior living. Figure 12 highlights the strong differences between the core sectors over the past five years. Compared to the other alternative asset classes, whose fundraising trends were quite homogeneous, real estate fundraising turned out to be different. While a decline in fundraising is similar, real estate was hit hardest. Given that the previous years were not great for the industry, it is even more notable that fundraising crashed by around 50% both in the number of fund closings and capital raised. The consolidation trend is also observable but to a lesser extent. Surprising findings are that around 20% of the capital raised is by Asia-Pacific-focused funds. Given the economic situation, it is not surprising, as most Asian countries (the notable exception is China) have not experienced such a surge in mortgage rates and a decline in real estate prices as most Western countries did. Nonetheless, the development is notable compared to the historical proportion in fundraising. Despite the consolidation trend, emerging managers could more than double the raised capital in percentages. With this development, first-time managers’ average size rose to $337m compared to $171m in 2021. A potential reason for this growth is the necessity for innovative strategies in the industry and new funds are more likely to offer such an approach to distinguish themselves from established funds. Despite the unfavorable macroeconomic conditions, Preqin expects the AuM of the industry to grow slightly lower than in the past six years. As of 2022, the AuM of real estate is around $1.4tn. Preqin forecasts the AuM of the industry to expand to more than $2tn by the end of 2027. Figure 13 summarizes these anticipated developments. Figure 12: Divergence of Real Estate Sectors Over the Past 5 Years, Sources: MSCI IPD, BlackRock Alternatives, December 2022 Figure 13: Forecasted AuM of Real Estate Separated by Geography Until 2027, Source: Preqin, December 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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