Can Private Markets Be the Alternative to Lofty Public Market Valuations?

This is the View From Apollo podcast, an ongoing conversation on alternative investing, economics, and the trends shaping up financial markets. In this episode of the View From Apollo, we talked to global well strategist Alex Wright about how elevated public market valuations might impact investment portfolios in 2025. There are heightened risks to the 6040 strategy, and I think the word for dealing with them in 2025 is diversification, even considering a straight rebalance. In a wide range in conversation, Alex and Apollo's chief economist, Torsten Slock, discussed the heightened risks in public markets, the outlook for private credit, private equity, and infrastructure in 2025, the future of private markets and wealth portfolios, and much more. So, without any further ado, let's get started. Hello everyone, I'm your host Torsten Slock, Chief Economist here at Apollo, and you're listening to the View From Apollo podcast. My guest today is Alex Wright, a partner and global wealth strategist here at the firm. In his role, Alex interacts with clients across the globe, discussing as their location strategies and deployment ideas for alternatives in wealth portfolios. I look much forward to picking his brain about current market conditions and finding out what's on his mind for 2025. So with that, thanks very much for joining us, Alex. It's a pleasure to have you here with us. Well, thank you, Torsten. It's great to be back on the show with you. All right. So we are starting 2025 with all eyes on Fed policy and the direction of interest rates. With that in mind, let me first provide our current outlook for interest rates going into 2025 as a foundation for our discussion. Then we can delve into what it means from an asset allocation perspective, both strategically and tactically. Does that sound good? That sounds wonderful. All right. So we come into 2025 with an economy that continues to be very strong. And the key issue is why has GDP growth for the last several quarters continued to be 3% when the Congressional Budget Office is the mid FGDP growth in the long run is only 2%. In other words, why is it that the economy continues to be so strong? And there are three reasons why the economy continues to be so strong. First of all, consumers have locked in low interest rates during the pandemic on mortgages. That means that consumers are less sensitive to Fed hikes and have therefore turned out to be stronger more generally than what people expected over the last several years. Secondly, in the US, we have an AI and data center boom that's also a very strong tailwind to growth. And finally, we also have had fiscal policy, the CHIPs Act, the inflation reduction act, the Infrastructure Act that has been very supportive of growth for the last several years. So we come into 2025 with the Fed having cut interest rates under basis points since September. But the growth outlook continues to be quite solid. And if we now add any potential Trump policies when it comes to tariffs, when it comes to restrictions on immigration, when it comes to lower corporate taxes and domestic manufacturers, we do look at 2025 as a scenario where we will probably continue to have strong growth, we will probably also continue to see maybe even some lift in inflation. So that's why in our December 2024 outlook, the title was that the economy is firing on all cylinders that we still view growth as strong and we therefore do view fundamentally that interest rates will stay higher for longer. We are looking at equities at very low of the evaluations. If you look at the trailing PE ratio for Tesla, for example, is just below 200. So you have a number of companies that look in our view quite expensive. So we have quite special setup with both strong growth, but at the same time very concentrated and very expensive stock markets. And that's why the starting point for our conversation here of course is that well growth is strong, but markets in particular stock markets are expensive, especially the top 10 stocks making up 40% of the index still trading a very lofty evaluation. And against this background, Alex, it seems that the two key components of a classic 6040 portfolio, namely equities and bonds are overvalued and could still face some hit wins in 2025 with the risk that interest rates could go up and stocks could go down. And perhaps not at the same level as we saw in 2022, but there's still some concern here where we might worry about that 2022 could come back in another form in 2025 where rates are going up and equities are going down. So what's what's your assessment of the risks for a 6040 strategy as we enter 2025? Sure, well, Toros and well said in the great foundation for the conversation, you're correct. There are heightened risk to the 6040 strategy. And I think the word for dealing with them in 2025 is diversification, even considering a straight rebalance. If we think about there was a significant run up in equities in 2023 and 2024, as we all know, north of 20%. If one didn't rebalance in each year, your 6040 is already skewing toward 7030. And if you were more heavily weighted at 70 to begin with, you're really closing it on 8020. So I guess many people are considering what to do. Most of that return, as mentioned earlier, was mag seven related about half of the gains in the index. So in other words, performance is coming from just a few players. And this is resulted in the most concentrated equity market that we have seen since the 1970s. And as you clearly state, PE ratios are very high. So the question is, should people let it run? Is there a phomo in the market fear of missing out? But even if you did pivot, the question becomes pivoting into a straight rebalance into bonds. Is that good, better, indifferent? I would say it's questionable at best. We're seeing spreads both in investment grade and high yield at 20 to 30 year tides. So the question is, one, from a high level, is there an equity risk premium on a forward basis? And are we getting a premium in fixed income? And I think collectively we would view that as a strong no at the moment. So what else should one do really becomes the addressable question here? That makes perfect sense. So in that sense, given the 6040 portfolio now has been through quite a rollercoaster ride here in the last few years, what do you think investors can do to address these challenges in 2025? Well, thank you for that. I think, look, the condom today is, how does one go about rebalancing that portfolio based upon the backdrop that we see today? We believe that private markets can help. And so when we get to the question of what to do, I would say first, we've seen major pension systems reduce public equity exposure to inside of 40% in certain circumstances, moving into private equity and private credit. So, directionally, we're seeing that at the institutional level. And one may say, well, why might that be? First, private could provide for alpha over a cycle on a potential basis. Certainly could potentially mute volatility provide diversification. And we're really fishing in a much wider pond. If you think about 87% of companies with 100 million of revenue or more are actually private in the US. And that number is higher in Europe. And so it's a broader investment universe fundamentally. So deeper pool. And obviously the public markets are much more narrow and concentrated fundamentally. Okay, so let's talk more about this in detail in terms of alternatives and private markets. In many way, alternatives has become a quite diffuse word while private markets have expanded so much. So let's break down the space and discuss its components separately. So if we start with private credit, I mean, talk to me about both meaning your outlook for the asset class as well as its function in once portfolio. Sure. Well, I'm glad that you're re addressing the word alternatives and making it more private market oriented. So alternative suggests that we're doing something different. The reality is we're lending money to companies buying companies very straightforward. So the outlook for private credit, it continues to generate incremental spread over public credit. And we think that's going to continue for the foreseeable future. Furthermore, as evidenced by much of your writings, we think higher for longer is definitely here, which is a benefit to private credit. We're all direct lending spreads have averaged 475 to 550 basis points over so far. So if you take that all in consideration with fees, you're looking in sort of a 9 to 10% unlevered return range fundamentally. That spread over public today is about 175 basis points, but we think risk adjusted over cycle. It could prove to be potentially higher than that. So if you're attractive fundamentally, that said, you know, we need to be very careful about where and how we're deploying into private credit. So first, I would say first lean dollar one top of the capital structure is important from a protective perspective segmentation is another consideration. And lean more toward large cap companies and third is vintage newer vintage post 2022 fundamentally the loan to value levels are much lower than what we saw pre 22 context 50 to 70% loan to value. And then at a high level, I would highlight a couple of things one what I'll call chapter one of private credit, which is the direct corporate lending. And then at a high level, I would say that's the direct balance of the state's business. That's what I just described, but I think what we'll be accelerating here quickly is. chapter two, not 2.0. It's a compliment, which would be asset back to finance. Financing a large opportunity set, and this is largely going to be found in investment grade format as well. So a couple of really nice options within private credit to consider when you're diversifying your portfolio overall. - Well, listening to your answer, I mean, it brings to mind what I would call the M2 conundrum meaning that investors still have more than $6 trillion part in money market funds today, and that's because folks seem to be comfortable earning the money market yield, which is roughly a little bit more than 4%, while waiting for the next move. But the question here is, is leaving cash parked in money market vehicles really the right strategy today? - Well, it's interesting. You and I have been speaking to each other about this for a good two years now, and you know, at a five and a half level looking back, I think some people were happy to just sit and wait. To your highlight now, when you're looking at, say, three month's reshary is at 4.3, what I'm gonna call the net net return is really eroded. What do I mean by net net? The first netting would be inflation. So, 4.3 minus call it two and a half, that'll get you to 1.8% return, and if you are in the top tax bracket of 37%, your second net gets you down to 1.1%. That's not going to take you to the promised land or your investment destination. And so, the question then becomes, how does one walk out onto the risk curve carefully? And so, many initially had been putting folks before this new reality of what's happening with rates into intermediate bonds, with the thesis that rate to a get cut aggressively, you'd get a rebound in dollar price to those bonds, so you would get yield and total return that proved out to be not correct. And I think the yield curve surprised many of that actually moved in that direction. So, the question then comes back to the idea of chapter one and chapter two of private credit. One, depending upon suitability and risk appetite, could move into direct lending to corporates. That would be chapter one or chapter two, which would be the asset back lending, investment-grade bias, of course. In either case, there is an ability to pick up yield relative to the risk-free rate or the money markets, as mentioned, and could prove to be an interesting way to diversify that portion of land's holdings. - Well, very interesting discussion of our private credit. So, let's now take the discussion to private equity, which of course is another key component of private markets. So, like you did with private credit, maybe talk to me about, again, both dimensions, namely your outlook for the asset class, as well as its function in one spot for you. - Sure, at a high level, the forward 10-year forecast that I have seen from the consulting groups is it would private equity as an asset class is still expected to fetch a premium over the public market equity results. And that's been rather consistent over the last decade or two, maybe not in the last year or two, but just directionally over that longer period of time. At a high level right now, I think we anticipate there'll be more deal activity, certainly with the change of administration, with the moving rates down from peak. But if we start unpacking private equity line item by line item, when we start with growth private equity, it's our view that growth private equity will continue to be somewhat challenged for a few reasons. One, loan to values, as mentioned earlier, when we were discussing private credit, are considerably lower than what they were three years ago, which means that there's gonna be a higher percentage of equity required to come in at the point of purchase. Second, the cost of those liabilities are significantly higher, nearly two times higher. And that's base rate oriented, that spread related as well. And so that's just fundamentally going to put pressure on the ability of growth private equity to generate the returns that they once did. Last point on that is many of the growth private equity players have enjoyed a lot of return from multiple expansion. That's over. We have not yet seen that too much this year, even in last year. So the reversion, if you will, as it relates to multiples, is also gonna put pressure on. So at its core, it means that growth private equity players are gonna have to work harder and faster on creating efficiencies and improvements in cash flow to generate historic oriented returns, which we think will be challenged. Value, value we think is an area to be. Obviously that's what we do. Purchase price matters, buying in at discounted multiples, distress or control, corporate carve outs, opportunistic buyouts, code for take private transactions. We believe they're still good value here. And then lastly, the secondary is business. Given that you're buying at a discount, giving that you're buying the known, not a blind pool, you can create very interesting risk adjusted returns through buying LP interests, but also GP continuations, whether that be single name or multi name opportunities at discounts. Those are some of the areas that we think are quite valuable within the private equity arena. Okay, so we talked about private credit. We talked about private equity. So let's now explore another concept that is gaining a lot of momentum in the private space, namely the concept of hybrid investments. So can you maybe first brief it, define what is a hybrid investment in the private markets today? Sure, well thank you for that. And we viewed it in a couple of ways. I would say there's a macro view to hybrid investments. Basically these are holistic private market solutions that would entail a combination of several asset classes into one strategy. And so those returns are going to be measured somewhat between traditional private equity and credit. So that's the hybrid connotation. The other though on the micro side, and I want to emphasize this is an area that I think the total addressable market will increase quite materially over the next one to three years. This is as you look at a particular company and you find that perhaps it was one of these older vintage capitalizations with loan to value at 50 to 70%. The reality in today's market is loan to value is 40 to 45%. What does that really mean? That really means that there is a hole in the capital structure when a refinancing requirement or maturity comes. So the question will become over time, what is the solution space capital that comes in to fill that gap? We think that is defined as a hybrid capital. Obviously we have strategies along those lines, which would be considered lending with equity, perhaps preferred stock, convertible stock, something along those lines that will help solve that building conundrum that is on the way and as the majorities come forward, this is going to create some really interesting abilities to deploy capital into those types of situations. Well, that's interesting. So let's talk more about the vintage difference. In other words, what are the differences between new vindages and older vindages at the moment? Sure. As mentioned, if you go back pre-22, the London values in the market in private credit were generally speaking 50 to 70%. Whereas in the newer vindages, they're 40 to 45%. And as the higher for longer reality is hitting these companies, we're seeing a combination of a few things that are cropping up. First would just be straight on non-aggrooals or defaults, but those levels look rather suppressed overall. And so what's beneath the hood is really the question that I would say a few things. One is we're seeing an increased use of paid and kind interest. So instead of cash, amendments are getting put upon these companies to give them more time, if you will. But at its core, that's not necessarily a good thing. It's building tail-reskin to the portfolios. And it's really putting off what could be the inevitable depending upon the situation. In other regards, we're seeing much more comprehensive amendments, which would take the form of the equitization of debt, what we call distressed exchanges, where the lenders in first-ling format take on less than 100% recovery and convert portions of their debt into equity and are hoping for the best over the longer term. So these are some of the realities that we're seeing in a higher for longer rate environment. Uncompany that, unfortunately, we're overlevered at the long time. The newer vintage coming back to that at 40% to 45%, it's a right-size capitalization for the interest rate environment that we're in today. You're looking at interest coverage ratios, generally speaking, 1.5 to 2 plus times, relative to older vintage, which is significantly inside of that. So this is why I say one needs to be discerning not all private credit is created equally. The segmentation and importantly, the vintage is make a significant difference in the realities of what you're doing fundamentally. Well, so before we get to a discussion about how to deploy capital in private markets, let's just finally take a look at the last asset class for private markets, namely real assets. Can you give us an overview of the asset class? And explain to our listeners how it's positioned as we start 2025? Sure. So real assets would include things, obviously, like real estate, but one area of focus for us is infrastructure. And infrastructure encompasses assets that provide essential services and are deeply embedded in the fabric of our society. So think airports, seaports, toll roads, power grids, and increasingly, an area with a lot of focuses digital networks like data centers and fiber optics. And so if we isolate that with a double click, if you will, AI and data centers are growing in parallel quickly. And since AI needs significant amount of data centers and energy, there's going to be a lot of investment opportunity there just to put some numbers around it. Right now, data centers account for about 1.5% of global power demand. That figure is projected to rise [BLANK_AUDIO] 7.2% by 2035. So that's about an estimated $1 trillion of global investment in that sector alone over the next five years. So private investors will have a share of that, but that's a significant consideration. Also private infrastructure returns are positively correlated with inflation in a way that other ISA classes are not. So they offer inflation link cash flows to help offset price increases. And then if I pull back to the macro just once more, you'll see that they're powerful macro economic tailwinds bolstering infrastructure today, including the federal spending initiatives that you've referenced many a time over the years and the global need to upgrade an aging infrastructure in more traditional format. - Very interesting. So that's a very comprehensive view of private markets, first private credit, private equity, hybrid and real assets. So let's not try to put it all together. What are the ways investors can consider deploying into private markets? - Sure. So again, I go back to the main thesis here, which is diversification and fundamentally are rebalancing of portfolio. So diversify, rebalance and then consideration of replacement with private market concepts. If I go back to fundamental basics, the capital asset pricing model, which we've talked about before, the reality is you need to look at the risk-free rate first and as you're adding risk to a portfolio, are you fetching appropriate risk premium across the board? As we reviewed the public equity markets, we think that there's little or even possibly a negative equity risk premium based upon what strategists are forecasting of zero to 3% for the public equity markets over the forward 10 years time, maybe 6% this year, but nonetheless, very muted. And where we see the public fixing come arenas with 20 to 30 year tites. So I think one needs to review those aspects very thoughtfully and carefully and then start adopting the appropriate level of private market exposure based upon suitability. If you isolate strategist forecasts, just to kind of bring this out in a little bit more precise way, you were mentioning the PE ratios. So S&P 500 upper 20s right now, I would also point folks to the cyclically adjusted PE ratio, which is touching 38, which is extraordinarily high. If you look at that and then look at the analysis that has been done in that regard on a 10 year forward, it would suggest less than 2% returns for the S&P 500. Taking it through different lens, the Treasury 10 year, we're sitting at about 4.7 right now. Some say there might be a risk of 5% at some point in 2025. If you were within that range from where we are today to five, again, the 10 year forward is kind of a 2.5 to 4% return for the S&P 500. When the risk-free rate is higher than that, where's the equity risk premium? We just don't see it. So here again, we think adding private markets could be useful, could diversify one's book, and actually at these levels, if the forecasts are accurate, provide for some interesting return parameters on a go-forward basis. - Well, Alex, this has been a fascinating conversation. Thank you so much for your insights. But before I let you go, you know, you've been here before. We have a tradition on the show that every guest gives us a personal recommendation that could be a book you're reading, a movie you watched, activities, in other words. What are you doing when you're thinking about private markets and following the days-to-day generations in financial markets, and that you and I talk about so much? - Sure, so funny enough to ring the holiday break, we had some indoors time, and so we watched Squid Games too. And for those that aren't aware of what that is, it's a fictional thriller that through a variety of children games pits contestants against each other. And one interpretation of what the meta message might be is what is the power of greed, but also a consideration of risk adjusted return within each of the games. Without giving away too much of the plot, it kind of intertwines some of these concepts, which is brought out in an aggressive and sometimes gory way, but nonetheless that kept me occupied for a little bit of time. I bought with my kids the dice game where you throw them up and you have to catch them. I bought that game and we've been playing that literally again yesterday, and it's just really, really hard. So I'm glad we survived yesterday evening after having played it, but it's very impressive. And very well done, the series. I actually also watched it over the holidays. My personal recommendation, although J.P. V. Sende who organizes all this and helps us, we always have a debate about whether I talk too much about soccer, but I am still quite frustrated Manchester United, there's only number 13 in the league. So I did sneak in here before Christmas when I went to London and saw Brent thought to play a game. They have a lot of Danish players and also a Danish coach, Thomas Frank, and thankfully they won. So they gave me a little bit better feeling on the soccer pitch, but it's been a tough year so far, watching Manchester United, but I'm keep on rooting and I watch every game and they play both during the week and also over the weekend. So still watching whether your favorite team wins and when they win, it's great when they don't and always debating what they can do better. So that's of course very important. You and I know this very well, of course, in all the work that we do together. So, but thanks so much, Alex. This has been absolutely fantastic. Thank you so much for being with us today. And of course, as always, we would like to thank you all so much for listening. Well, Torsen, thanks again for having me on the show. It's always a pleasure to be here. Thank you to the audience. Certainly appreciate your attention and good feedback that we've heard on all of these. Thanks again and happy New Year. Thank you. This podcast was recorded on January 9, 2025. Thanks for listening. A quick reminder that you can subscribe to this podcast on Spotify, Apple Podcasts, and Audible, or by visiting apoloecademy.com. Our educational website dedicated to alternative investing, where you can also sign up to have Torsen's Daily Spark Economic Blog delivered directly to your inbox. Once again, thanks for listening. Apolo Global Management Incorporated Together with its subsidiaries, Apolo makes no representation or warranty expressed or implied with respect to the accuracy, reasonableness, or completeness of any of the statements made during this podcast, including, but not limited to, statement-subtained from third parties. Opinions, estimates, and projections constitute the current judgment of the speaker as of the date indicated. They do not necessarily reflect the views and opinions of Apolo and are subject to change at any time without notice. Apolo does not have any responsibility to update this podcast to account for such changes. There can be no assurance that any trends discussed during this podcast will continue. Statements made throughout this podcast are not intended to provide and should not be relied upon for, accounting, legal, or tax advice, and do not constitute an investment recommendation or investment advice. Investors should make an independent investigation of the information discussed during this podcast, including consulting their tax, legal accounting, or other advisors about such information. Apolo does not act for you and is not responsible for providing you with the protections afforded to its clients. This podcast does not constitute an offer to sell or the solicitation of an offer to buy any security product or service, including interest in any investment product or fund or account managed or advised by Apolo. Certain statements made throughout this podcast may be forward-looking in nature, due to various risks and uncertainties actual events or results may differ materially from those reflected or contemplated in such forward-looking information. As such, undue reliance should not be placed on such statements. Forward-looking statements may be identified by the use of terminology, including, but not limited to, may, will, should, expect, anticipate, target, project, estimate, intend, continue, or believe, or the negatives thereof or other variations thereon, or comparable terminology.