The impacts of economic downturns can be felt in many areas: bank accounts, investment accounts, home prices, grocery prices, and the list goes on. As prices rise, the power of cash and liquid assets decreases. However, private market investing has consistently outperformed public markets during the largest market downturns of the past 25 years, according to Schroders Capital.[1] In this blog, learn more about diversifying your portfolio with private market investments during economic downturns.

Private Market Investments During Economic Downturns

Before diving into how to diversify your portfolio with private market investments, it can be important to understand why more traditional assets like stocks and bonds often underperform during economic downturns.

Stocks

Possibly the most common public market investment, stocks can be vulnerable to rising costs and interest rates. Companies may face higher input costs, like materials, labor, and energy, which can squeeze profit margins and hurt corporate profitability. Additionally, reduced consumer spending may impact sales due to weakened demand for goods and services. And because stocks are one of the more liquid investments that can be bought or sold quickly, investor perception and press may cause mass sell-offs, reducing the stock price and putting pressure on public companies.

Bonds

Another common public market investment tool, bonds, particularly long-duration ones, may struggle in economic downturns as fixed coupon payments lose purchasing power over time. For example, a bond that yields 4% becomes less attractive as inflation rises higher above that number, and real returns turn negative. Additionally, bond prices traditionally fall when interest rates rise[2], meaning investors that hold existing bonds may face capital losses if they need liquidity before the bond matures.

Private Markets During Economic Downturns

While public market investment alternatives can be impacted by economic downturns, private market investments can have structural advantages that allow them to experience less significant drawdown and a quicker recovery than public equities such as during the Dot-Com Bubble, the 2007-2009 global financial crises, and 2020 COVID-related market events, according to Neuberger Berman.[3]

The following are some of the characteristics of private markets that can be beneficial during periods of economic downturn.

Illiquidity

While illiquidity may be seen as a risk when making private market investments, it can also become a tool during economic downturns. Public markets are highly sensitive to news cycles and short-term economic data, which can lead to sharp swings during economic downturns. However, due to the illiquid nature of private market investments and long holding periods, private market assets aren’t as heavily impacted by these same factors. Investors are not able to act on the temptation to sell during market downturns, enabling businesses to adapt to economic pressures without constant scrutiny from public market investors.

Additionally, private market valuations are based on fundamental performance, not daily trading activity. This means company valuations could also avoid sentiment-driven volatility.

Ability to Adapt

Private businesses may be more able to adapt to inflationary pressures without the scrutiny of public market investors. By making independent decisions, businesses may have mechanisms to pass rising costs onto customers or benefit directly from inflation. For example, real estate landlords have the ability to raise rent in response to higher expenses, while infrastructure assets may have contracts that adjust revenue based on inflation metrics. Additionally, private businesses may also be able to take proactive steps to help mitigate inflation’s impact, such as renegotiating supplier contracts, optimizing operations, or shifting pricing strategies. Without the short-term profitability pressure from public investors, private businesses can make strategic decisions that prioritize long-term resilience.

Which Private Market Investments?

Each type of alternative investment has unique structure and inherent characteristics that could be beneficial during economic downturns:

Real Estate

Considered in some cases a hedge, property values tend to decrease, which could provide benefits to real estate investors seeking to acquire new properties. On the other side of real estate investing, self-storage facilities are generally considered to have steady demand despite economic cycles. Industrial and warehouse properties can also be supported during economic downturns due to the fact that many commercial tenants generally hold longer-term leases.

Infrastructure

Infrastructure assets may also be unaffected by periods of economic downturns, due to the stability of demand . Utilities, toll roads, and airports frequently operate under regulatory frameworks that allow for periodic price adjustments. Additionally , essential services like energy and water generally have stable demand during economic downturns.

Private Equity

Private startups may be able to navigate economic downturns by improving operational efficiency, increasing prices, and the flexibility to adapt without public pressures can help hedge against inflation. Startups may be better able to adapt pricing models, optimize costs, and capitalize on shifting consumer demands through innovation more swiftly and seamlessly than public counterparts.

Final Thoughts

While there aren’t any investments that necessarily perform well during economic downturns, investing in private markets can offer unique opportunities during these periods of uncertainty. Real estate, infrastructure, and startups have differentiating mechanisms to pass on costs, pivot, and adapt in changing times. However, no investment is immune to economic downturns and all investments carry a high level of inherent risk.

For investors concerned about their investments during economic downturns, consider diversifying your portfolio. For this, you may want to consider talking to a financial professional who can best help you understand diversification and portfolio allocations.

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[1] https://www.schroderscapital.com/en/global/professional/insights/private-equity-s-resilience-during-major-crises-a-25-year-analysis/

[2] https://www.investopedia.com/articles/bonds/09/bond-market-interest-rates.asp

[3] https://www.nb.com/en/global/insights/the-historical-impact-of-economic-downturns-on-private-equity

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The information presented here is for general informational purposes only and is not intended to be, nor should it be construed or used as, comprehensive offering documentation for any security, investment, tax or legal advice, a recommendation, or an offer to sell, or a solicitation of an offer to buy, an interest, directly or indirectly, in any company. Investing in both early-stage and later-stage companies carries a high degree of risk. A loss of an investor’s entire investment is possible, and no profit may be realized. Investors should be aware that these types of investments are illiquid and should anticipate holding until an exit occurs.

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