Capital calls are not the only problem for investors in private markets. Even their successes are creating headaches.
As many alternative assets outperformed public markets in recent years, institutions have broken past fixed limits on the proportion of their portfolios that can be allocated to private markets.
While this so-called denominator effect may be exaggerated -- because there is a lag in revaluing private assets to reflect the very latest market conditions -- it does have the potential to trigger increased selling at a time when it is least wanted.
And the sums involved could be huge. A significant amount of the easy money pumped into the financial system by central banks during the pandemic found its way into unlisted assets, which grew to $10 trillion globally by September 2021, a fivefold increase from 2007, according to figures from investment data firm Preqin.
“There’s a regime change of sorts in the macro world and in markets that we need to take hold of,” Stephen Klar, president and managing partner of Wellington Management Co., said at the Global Financial Leaders’ Investment Summit in Hong Kong on Nov. 3. “We’re working with our clients on thinking through how to really get that asset allocation back to a more diversified and rebalanced manner.”
There are two separate issues affecting the private asset/alternatives markets. The first is tightening liquidity. As global money supply growth contracts the weight of money argument for supporting private asset prices is much less compelling. The second is the technical issue described above.
Without ample access to additional cash, investors will be less forthcoming with investments and if inflated values have maxed out allocations, they will not be able to increase position sizes. That is a recipe for lower valuations.
This chart takes the sum of M2 totals for the Eurozone, China, United States, Japan, South Korea, Australia, Canada, Brazil, Switzerland, Mexico, Russia and Taiwan then redenominates them to US Dollars.
There have been several occasions when the total traded below the 200-day MA over the last twenty years. However, on this occasion not only has the index encountered resistance in the region of the MA but is now trending lower. Since the peak in April central banks have removed $7.2 trillion from circulation globally, That equates to a 7% contraction in global money supply.
There is also a strong Dollar influence on the contraction in the redenominated central bank balance sheet totals chart.
Global interest rates are rising at the fastest pace in decades and global money supply is contracting. The strength of the Dollar is the big liquidity lever. If the Dollar Index rolls over, it will be a catalyst for significant repositioning, mostly into non-US assets and commodities like oil and gold.
The Dollar Index will need to sustain a move below 110 to break the consistency of the medium-term uptrend.