Ask the experts: What is stirring our clients (and moving the financial markets) in November 2024
We are always available to our customers for concerns and questions about their portfolios. As a representative of this, once a quarter we summarize the most frequently asked customer questions and the answers provided by our experts, thus giving you direct insights into our asset management and investment advisory services.
Geopolitics
How can investors profit from a post-war rebuilding of Ukraine?
Kaiser Partner Privatbank: The war in Ukraine will soon be entering its fourth year. Some indications suggest that the armed conflict will near its end or will freeze in its current state next year. If one studies the map of the areas of Ukraine occupied by Russia, it appears that the war already has practically ground to a standstill today as is. The Russian army has made only marginal territorial gains over the last two years at an enormous cost. Over 600,000 Russian soldiers have been injured or killed in the conflict by now, according to the latest estimates. The war has long since lost unstinting public approval in Russia – a growing majority opposes a second mobilization wave. Although Russia appears to have lived fairly easily with the sanctions thus far and its wartime economy is running at full throttle, there nonetheless might be incentives and compulsions for Vladimir Putin to content himself with the conquest of the areas currently occupied by Russia in eastern Ukraine and to sell that as a victory to the Russian public.
Volodymyr Zelensky, too, is facing mounting internal and external pressure. Enthusiasm for the resistance has long since faded among the Ukrainian public, and fewer and fewer people now consider the conflict an existential matter. Moreover, recent surveys show that a growing percentage of the public would be willing to accept a loss of territory to end the war. NATO, meanwhile, is exhibiting a lack of interest in helping Ukraine recapture all of the lost territory, which would require a massive increase in military aid and an attendant acceptance of a potential dramatic escalation (including the risk of a retaliation with atomic weapons by Russia). (Unfettered) support for Ukraine is crumbling in Western governments, not least of all in Germany. And there is growing concern that a continuation of the armed conflict would turn Ukraine into a “lost country” lastingly devastated by societal and economic harm and irreparable demographic decline.
The war may now be on the cusp of a crucial turning point in the wake of Donald Trump’s election victory. Pressure on the president of Ukraine to seek a negotiated solution will increase tremendously. How can investors position themselves for a possible end to the war in Ukraine? No promising recommendations for the near term can be made because any alpha that the conflict generated already vanished by the end of 2022 at the latest. The financial market, unlike the media, has been desensitized to developments in Ukraine ever since then. An entire array of market prices for things like platinum, palladium, defense stocks, natural gas, and crude oil were affected for a short time only at the outset of the armed conflict, but intermittent price outliers soon corrected and are now back under the influence of normal market forces. The price of wheat is particularly noteworthy here: it initially jumped by more than 50%, but swiftly fell back to its original level just three months later when it quickly became apparent that there would be no global grain shortage.
No alpha on offer | The Ukraine conflict had only a short half-life on markets
Price performance before and after February 24, 2022 (= 100)
Sources: Bloomberg, Kaiser Partner Privatbank
In the longer run, however, there definitely would be investment opportunities after an official, or possibly merely “unofficial”, end of the armed conflict. The costs to rebuild Ukraine are immense. Calculations made by the World Bank last summer, which probably are already outdated by now, put the cost of rebuilding the country in the years ahead at USD 486 billion. It takes an awful lot of private capital alongside money from official sources to shoulder costs of that magnitude. An initiative spearheaded by financial giants BlackRock and JPMorgan aims precisely to facilitate the mobilization of private capital. Their USD 15 billion Ukraine Development Fund could launch once the military hostilities have ended. However, investment vehicles of that kind are likely to be reserved exclusively for institutional investors for the time being. Nevertheless, individual private investors may also be able to partake in investment opportunities in Ukraine in the very long term because if a lasting peaceful solution is achieved, private-market infrastructure funds are also likely to get involved in Ukraine a few years from now. They by now have become accessible to a wider public in the form of semi-liquid evergreen funds.
Investors in the stock market, on the other hand, can already position themselves these days even though the link with Ukraine is very indirect in part, such as in the case of shares of the companies Nestlé and Bayer, which are building new plants or enlarging existing production facilities in Ukraine. European arms manufacturing firms ultimately are also beneficiaries of the geopolitical developments in Europe. Ukraine looks set to massively rearm in the years ahead, and considerable military investment needs also exist in the rest of Europe because the USA under the coming Trump administration threatens to substantially scale back its engagement in Europe and because Russia likely will continue to play a menacing role even once the armed conflict in Ukraine is over.
European Union
Mario Draghi has given the EU a grim diagnosis in his report on “The Future of European Competitiveness.” What is Draghi’s formula for bettering the situation, and what are its chances of succeeding?
Kaiser Partner Privatbank: “Whatever it takes…” – with those words (and many more), former European Central Bank president Mario Draghi ended the panic over the euro in 2012 during the darkest days of the European debt crisis. And now this past September, Draghi presented a 393-page report on “The Future of European Competitiveness.” He has a big goal also in this endeavor, which is nothing less than averting a (further) economic decline in Europe, which is on the “brink of an existential crisis,” in his words. Draghi’s diagnosis is more than sobering: Europe’s productivity and investment gap versus the United States is large and growing, and the trend versus China is similar. The main cause of that is the much lower level of investment and the resulting lower productivity in Europe. Businesses in Europe are hesitating to invest because they foresee little growth and are thus creating a vicious circle that stifles economic progress. According to Draghi, Europe has already missed the boat and risks becoming irrelevant, particularly in the face of advancements in the digital economy and artificial intelligence. Draghi also questions Europe’s ability to cope with the new geopolitical realities, which include increasing protectionism, evolving supply chains, and more aggressive industrial policies being pursued by other developed nations.
Anemic productivity | Widening lag behind the USA
Labor productivity in European Union relative to USA (USA = 100%)
Sources: European Commission, Kaiser Partner Privatbank
In his report, Draghi makes a total of almost 150 different recommendations on sectoral policies (e.g. regarding energy, digitalization and advanced technologies, aerospace, transportation, etc.) and horizontal policies (including closing the skills gap). According to Draghi, it would take EUR 800 billion of annual funding over the next ten years to close the investment gap. A large part of that money would have to come from the private sector, but another part of it could be secured through public investment (including through the issuance of new collective EU bonds). Meanwhile, not all of the proposed reforms require additional funding. Draghi also calls for the dismantling of cumbersome regulations, an easing of competition rules, legislation to facilitate cross-border corporate mergers, pursuit of joint procurement in the defense sector and, last but not least, a deeper integration of services markets, including a Capital Markets Union with a centralized financial supervisory authority. He additionally calls for changes to the EU governance framework, which currently requires member-state unanimity on most decisions and hinders reforms. Draghi instead advocates for implementing agreements without a unanimous consensus.
Massive investment need | Undisputed, but fundable?
Additional annual investments according to Draghi report (in billion Euro)
Sources: European Commission, Kaiser Partner Privatbank
Given the frustratingly slow pace at which change in the European Union has been brought about in the past (at least not during economic crises), it is easy to be skeptical about these ambitious proposals. However, reports like Draghi’s really can have a big impact. To cite an example, the 1989 Delors report, which was initiated by then-European Commission president Jacques Delors, laid the cornerstone for the economic integration of Europe, for the creation of the single European market and, finally, for the establishment of European monetary union at the end of the 1990s. Draghi’s new report could serve as a strategic anchor for European policymaking again this time. Calculated optimism is appropriate here because the timing is good for at least three reasons, or at any rate it is better than it would have been had the proposals been made ten years ago:
- Because, first, the long-anticipated demographic crisis is being felt today. The working-age population in the EU-27 will shrink by up to 5% over the next ten years. In the face of (domestic) political constraints, offsetting this decline with increased immigration will probably be much harder to accomplish today than it would have been one or two decades ago. Hence, faster productivity growth will be necessary to at least maintain the current rate of economic growth.
- Because, second, policymakers have only just come to the realization that they can’t simply continue to bury their heads in the sand. Their eyes have been opened by several jarring developments over the last five years, including Russia’s invasion of Ukraine, the increasingly apparent impacts of climate change, the rapid advancement of new technologies, and the ways in which the USA and China are strengthening their ability to compete.
- And because, third, European policymakers in recent years have already taken a series of important steps toward a deeper integration. This year, for example, a strategy for the European defense industry was unveiled. And last but not least, European collective debt is no longer taboo. Back in 2020, EU member states agreed for the first time to fund programs like SURE and Next Generation EU by issuing common EU bonds. It will likely be hard to put that genie back in the bottle. Or in the words of Mario Draghi: “The use of collective debt securities has a well-established precedent.”
Demographic challenge | Time to wake up (at last)
Working population (2023 = 100)
Sources: European Commission, Kaiser Partner Privatbank
Whether the recommendations in Draghi’s report get quickly and extensively implemented and how big a role collective debt plays in the process will depend in part on who benefits from the plans. At first glance, “Super Mario” appears to have done a good job here because his proposals indeed have a little something for everyone. Scandinavia and the core EU countries stand to benefit from the sectoral policies, including in the areas of automobiles, green technologies, and pharmaceuticals. The peripheral countries would be the winners from the horizontal policies, which are mainly aimed at closing existing gaps in the areas of workforce skills, innovation, and investment. East-Central European countries like Poland, Czechia, Slovakia, and Hungary, in turn, would profit from the plan in its entirety, largely because they have the greatest need to take action in the area of infrastructure.
Conclusion: Better late than never – Mario Draghi’s report is a wake-up call that hopefully has come just in the nick of time. There admittedly are plenty of obstacles that stand in the way of a full implementation of his proposals. Not least of them is the sheer magnitude of the funding required, which means that the issue of collective borrowing will remain a central topic of discussion for the foreseeable future (despite Draghi’s claims that it is not an essential element of the plan). Moreover, some parts of the report are bound to get diluted during the negotiation process. Nevertheless, the fact that each EU country would benefit from the overall plan inspires optimism. Key elements of the plan could be implemented, and countries like Germany that heretofore have been skeptical toward collective borrowing could change their minds about it sooner or later in the face of the existing urgency to take action. The necessary further development of the EU won’t happen overnight, but the European Commission and the EU member states now have a carefully thought-out instruction manual in their hands that they can and must use as a guide so that Europe can retain its relevance and preserve its prosperity.
Financial markets
Why are so few companies going public even though stock markets are booming?
Kaiser Partner Privatbank: Stock markets are climbing from one high to the next, but hardly a company wants to go public to partake in the rally? It isn’t exactly as dire as that. There were some sizable initial public offerings (IPOs) around the world in October, including stock-market debuts by Tokyo Metro, Polish retailer Zabka, Hyundai Motor India, and the Springer Nature publishing company in Germany. However, there are no traces of euphoria among investors or companies themselves – the earlier times when IPOs were the hot topic of conversation during coffee breaks and many share issues were several times oversubscribed and could reap investors huge price gains in the first hours of trading are more distant than ever these days. Even if one strips out the 2020–2021 IPO heyday fueled by the ultra-accommodative monetary policy at that time, the aggregate IPO volume this year nonetheless lags behind more normal phases like the 2017–2019 period. The IPO volume has plummeted this year particularly in China, where “quality before quantity” has been the politically decreed motto since last spring. But even in the larger, more liberal, and by far the most important capital market – the USA –, where the AI revolution and other breakthrough advancements would provide enough reasons for an IPO revival, fewer than a dozen technology companies have sought a stock-market listing this year. It’s low tide also in Switzerland, where only one company – Galderma – has ventured onto the public stage so far this year.
IPO drought | Many companies prefer to stay private
IPO volumes in USD billion on the top ten stock markets for new issues*
Sources: Dealogic, Kaiser Partner Privatbank
*Data up to October 31, 2024; rest of top 10: India, Japan, Australia, South Korea, Germany, UK, Saudi Arabia
A combination of a sparse supply of (good) companies, inadequate investor demand, and the adverse side effects of well-intended regulations is the cause of the IPO malaise. Many companies that actually would be ripe for an IPO prefer to stay private these days for one of two reasons: either because their last valuation stems from the euphoric 2020–2021 period and is still unrealistically high so that an IPO at a fair value would mean painful losses for their private investors, or more generally because there is enough private capital around, which means that an IPO solely for the purpose of raising capital is unnecessary and would in fact be associated with additional costs, reporting requirements, and pressure from the public and maybe even from activist investors. There is a deficiency on the demand side, in turn, because there are ever fewer active stock pickers and more and more money is flowing into passive ETFs. So, there is less spare capital available to invest in IPOs. And finally, regulations that result in ever fewer equity analysts covering (smaller-sized) companies (MiFID II) or that cause European insurance companies to hold only small equity positions for precautionary reasons (Solvency II) are not conducive to whetting investor interest.
How long will the IPO drought continue? A return to the glorious days of old is unlikely to happen anytime soon, but not necessarily to the detriment of investors because a simple normalization would possibly hold something good in store. Since IPO hype has completely vanished, investors can expect to see some interesting and, above all, well-priced deals next year that will likely especially include companies currently owned by private equity firms and funds, whose managers are facing mounting pressure to return capital to investors. For private equity managers, IPOs are a potential exit route to raising the necessary liquidity, particularly by taking the bigger jewels in their portfolios public. IPOs of that kind are especially interesting for investors because private equity managers have their reputation to lose and cannot afford to stage (multiple) IPO flops. Those companies that went public with a sustainable good story and a fair valuation were the particularly successful ones in recent quarters.
Even if there are likely to be more opportunities on offer in the near future, one thing remains imperative: investors must continue to do their homework and carefully scrutinize both the rewards and risks of an IPO candidate. An important part of the homework is regularly reviewing one’s strategic asset allocation. Anyone who doesn’t have any exposure to private markets yet should close that gap in his or her portfolio. That way, investors can participate in the performance of the increasing number of companies that are growing successfully outside the stock market.
Private markets
Is private credit still attractive in the wake of the interest-rate pivot by central banks?
Kaiser Partner Privatbank: The private credit asset class has been on a successful course and has registered robust growth in recent years. The amount of capital invested by now in private credit loans worldwide is estimated at approximately USD 2 trillion. This growth has been driven mainly from two sides. On one hand, banks have scaled back their lending business, opening a void for private credit managers to fill. And on the other hand, investor appetite for private credit has increased, in no small part because new semi-liquid investment vehicles have made it much easier for them to enter this asset class. While central banks’ last rate-hiking cycle led to significant price drawdowns in some private-market segments (venture capital and real estate) or to flat returns at best in others (private equity), private credit fulfilled investors’ wishes for uncorrelated and steady high returns. Higher benchmark interest rates and widened credit spreads enabled returns of 12% and upward (in US dollar terms) over the last two years. Everyone – investors and asset managers alike – has been seeking lately to get in on the party. Even BlackRock, the world’s largest asset manager, is currently on the prowl for opportunities to strengthen its private credit business and may be on the verge of acquiring HPS Investment Partners, one of the last sizable independent private credit managers (with over USD 100 billion of assets under management) left in the industry.
Banks making a comeback | More competition again for private credit
Volume of new lending for leveraged buyout (LBO) transactions, in USD billion
Sources: Pitchbook, Kaiser Partner Privatbank
Observers watching these developments from the sidelines have to ask themselves if they aren’t signs of overheating. When too much money flows into an asset class too quickly, theoretically that should lead to a decrease in expectable returns, especially if corporate demand for loans does not increase in equal measure and effectively leaves a surplus of capital on hand. In fact, today private credit managers aren’t just increasingly competing with each other for the same deals – banks, too, by now have returned in greater force to this market. Bank loans are a suitable and usually cheaper financing alternative, at least for financially sound companies. The resulting consequence is that competitive pressure compresses credit spreads and enables corporations to refinance existing (expensive) loans at better terms and conditions.
Competition revives business | Companies are shopping for cheaper lending conditions
Refinancing volume in USD billion
Sources: Pitchbook, Kaiser Partner Privatbank
The intense competition has caused credit spreads to contract in the meantime by more than 100 basis points from last year’s highs. What signifies cheaper financing for corporations reduces potential returns for those invested in private credit. But that’s not the only effect of the heightened competitive pressure. It also induces private credit managers to loosen lending conditions and to content themselves with smaller safety margins and tends to degrade the quality of the loans in their portfolios. The volume of PIK (payment in kind) loans, for example, has continually increased in recent quarters. With PIK loans, corporate borrowers do not pay interest with cash, as they normally would, but instead with additional debt equal to the amount of interest owed. That provides relief for the borrower in the near term, but in the long run, the deferred and usually further increased interest obligation enlarges its debt load, making the loan deal riskier also for the private credit manager and for the last link in the chain, i.e. the people or entities invested in the private credit fund.
Competition and interest-rate pivot… | …mean a lower return for investors
Credit spreads on new private credit deals
Sources: Pitchbook, Kaiser Partner Privatbank
Should investors now exercise caution with private credit? A clear-headed approach to this asset class is at least advisable. Mounting loan defaults would be a logical consequence against the backdrop of deteriorating credit quality and would diminish the returns earnable in the private credit space. Meanwhile, the competitive pressure between private credit managers and versus banks looks set to persist. Altogether, these developments could erode the yield premium on illiquid private credit versus liquid syndicated loans that has been observable in the past. Private credit loans also appear poised to lose attractiveness because central banks will cut policy rates further in the quarters ahead. However, all of that is no reason to bid farewell to this asset class. Annual returns of 8% and upward should still be achievable with private credit over the next 12 to 24 months, and with much less volatility compared to bond markets to boot.
Private markets
Are private equity’s best days gone?
Kaiser Partner Privatbank: That’s exactly the question we asked ourselves last summer. Our query had been preceded by a booming stock market in the first half of 2023, which outperformed private equity by a wide margin. Our conclusion at that time was that it was merely a one-off episode and that private equity would likely resume performing better than exchange-listed companies in the long run, like it had done in the past. Fifteen months later, it’s time to take sobering stock of what’s happened in the interim because equity markets have continued to surge higher over the past several quarters. The broad Russell 3000 index has gained more than 50% since January 2023, outpacing the private market by around a factor of three. So, are private equity’s best days indeed over after all?
A look back at history is helpful at this juncture. The present situation can best be compared to the performance cycle during and after the 2007/2008 financial crisis. The performance of private equity was sluggish also on both ends of that timeline. What was desirable on the way south during the price drawdown (because it soothed nerves) necessitated patience during the subsequent recovery phase. That’s because stock markets regained twice as much ground as private equity did during the early stage of the recovery. They corrected preceding overreactions that never occurred on private markets. During the following two years (the late stage of the recovery), private equity reestablished the performance lead that this asset class is known for and which is justified in part by an illiquidity premium and by the better fundamentals of privately held companies on average compared to publicly traded corporations.
In the third period | Time for private equity?
Performance cycle: private vs. public markets (financial crisis and post-pandemic)
Sources: Dawson Partners, Kaiser Partner Privatbank
This historical flashback inspires optimism for today. A return to concentrating on the fundamentals could set in again this time in the quarters ahead, and they clearly argue in favor of private equity. The valuation of the Russell 3000 climbed by 2.2x to 16.6x (x = EBITDA for the prior 12 months) between January 2023 and June 2024, whereas the valuation of the MSCI Private Equity Index edged up by only 0.7x to 14.2x during the same period. And while the aggregate earnings of the companies in the Russell 3000 index rose by around 5% on an annualized basis over those 18 months, the earnings of privately held companies grew nearly twice as fast during the same period. The prerequisites for a renewed outperformance phase for private equity are therefore in place. But what’s been missing thus far is a revival of the M&A market in general and a resuscitation of deal activity by private equity managers in particular. That’s because exits are a major performance driver – over the last 18 years, private equity managers on average have sold their portfolio companies at a 28% premium to last book value. However, the private-equity carousel has been spinning very slowly in recent quarters, with managers selling the fewest number of companies since the year 2009. There’s a lot now suggesting that the machinery will shift a gear higher next year. The set of corroborating indications includes not only booming stock markets, which normally spur a pickup in activity also on private markets with a time lag, but also the outcome of the US presidential election. After all, the prospect of lower taxes and deregulation is exactly what the financial jugglers on Wall Street want to hear.
In the third period | Time for private equity?
Financial metrics: private vs. public markets (early recovery 01/2023–06/2024)
Sources: Dawson Partners, Kaiser Partner Privatbank