Dear Investors,

When we left off at the start of 2024, uncertainty lingered in the wake of one of the most challenging periods for Alternatives investing in recent memory. At first glance, in the six months since, it would appear that not much has changed. However, the economic data in the U.S., starting in the month of July, has marked a significant turning point from a macroeconomic perspective:

Labor markets blinked. The July jobs report revealed unemployment at 4.3%, up from a higher-than-expected 4.1% print in June and marking the fourth consecutive monthly increase. While the rate moderated slightly to 4.2% in August (as expected), recent downward revisions to U.S. job growth (the largest since 2009) have painted a markedly weaker picture than initial estimates suggested and August nonfarm payrolls fell short of consensus forecasts. Job markets have come into sharper focus as the U.S. Federal Reserve (Fed) must balance rising unemployment risk with lingering reinflationary concerns, particularly in light of recent CPI data.

Inflation has peaked. July’s 2.9% headline annual CPI print confirmed a continued decline in inflation, marking the first dip below 3% since early 2021. After signaling that the “time has come” for policy to shift its attention to the labor side of the equation, the Fed followed through in a big way by slashing its benchmark interest rate by half a percentage point. Markets are pricing in another 25 bps cut in November and 75 bps of additional cuts in total by year-end. Falling interest rates should provide a tailwind for interest rate-sensitive sectors such as real estate with a recovery in Europe already underway.

Volatility has spiked. Speculation abounds that the largest stocks have entered overbought territory. Positive momentum fueled by AI enthusiasm lifted the “Great Eight,” but recent turbulence in technology stocks has highlighted the risks of high market concentration. Accordingly, the case for diversification remains a strong one.

Externals risks abound. Bouts of geopolitical volatility have been par for the course this past year and international relations appear tense as the war in Ukraine continues and resolution in Gaza remains elusive. The 2024 U.S. Presidential election will add an extra element of uncertainty (despite there being no clear great economic outcomes no matter which party is elected) while snap elections in France amongst others across the European Union have exposed potential fractures across the bloc.

Entering private markets.

By transformation, we mean a deliberate and significant shift.

In an environment where public equity valuations seem stretched, at least from a historical perspective, and rates have likely peaked, where should investors go to capitalize on the megatrends that are re-shaping the opportunity landscape?  We believe investors seeking diversification, thematic exposure, income, and higher returns are increasingly turning an eye towards private markets. The asset management industry has been rapidly evolving in response, with private capital poised to be one of the most powerful agents of transformation. With this in mind…

Here are three relevant themes for the remainder of 2024:

1) Real Assets demand is underpinned by long-term megatrends

While the noise has continued, for example amidst a heightened focus on politics following European elections in June and July that have seen shifts in governing power (e.g. France, UK), the policy foundation for infrastructure remains solid with the agenda focused on facilitating private capital investment in areas such as the energy transition and European economic independence. Consensus in the European market towards the need for energy security and digital capabilities help ensure that the policy environment will remain supportive and continue to evolve to address the needs of investors in the future. Against this backdrop, we continue to see value in the European midmarket for infrastructure. Key trends of demographics, digitalization, deglobalization, and decarbonization are also creating thematic and sectoral opportunities in Real Estate as the world adapts. Onshoring and nearshoring in the semi-conductor and green energy industries are trends to watch, with the potential to boost demand near expanding manufacturing hubs. This is complemented by short-term tailwinds as transports assets post-COVID recovery are brought back to market and as the next rate cutting cycle gets underway, helping to accelerate transaction volumes in the back half of 2024 and 2025. 

2) The importance of diversified origination sources is becoming more evident to investors 

Private capital is playing an increasingly important role in financial markets. At roughly $26 trillion, gross assets have nearly tripled in size, eclipsing the U.S. commercial banking industry in terms of gross asset value and capital raising. Private credit in particular is playing an ever-bigger role amidst traditional lender pullback and as innovations in structuring expand access for investors. Despite private credit’s extraordinary growth over the past several years, forecasts suggest there is a lot more room to run. Once adversarial relationships between asset managers and banks are rapidly evolving into partnerships, predominantly in direct lending but with some observable expansion into asset-based financing – a trend we expect to continue. The most innovative, adaptable, and forward-thinking firms are likely to emerge winners as the industry is forced to embrace the complexity, including data integration, structuring, and governance challenges, that accompany this attractive opportunity set. Further, asset managers with strong origination capabilities across multiple channels are expected to be best-placed to secure the access, quality, and diversification of investments that can meet the demands of sophisticated clients. At DWS, our partnership with the broader Deutsche Bank Group remains a key point of strength and differentiation in sourcing differentiated exposure for our clients.

How is DWS Alternatives transforming to meet these needs?

While DWS has continued to demonstrate relative performance strength in a challenging environment, markets have continued to emphasize that diversification is essential for long-term success. We have stayed the course in our core areas of strength such as Real Estate and infrastructure and have been busy at work enhancing our Alternatives private credit capabilities. These enhancements should better enable us to meet our client’s needs and provide a degree of insulation from market cycles.  

• The buildout of our Alternatives credit franchise continues as we seek to capture market share within the space, which is forecasted to grow at 11% CAGR 2023-28.^[1] Thus far in 2024, key hires are enabling accelerated progress in our European CLO (Collateralized Loan Obligation) and Capital Solutions businesses. Diversified credit, insurance solutions, and asset backed lending are future areas of focus for this rapidly growing area of our franchise. We are in a strong position given our deep insurance connectivity and diversified origination capabilities.
• Infrastructure remains a targeted growth area amidst positive recovery in investor and fundraising sentiment which is supporting fresh allocations and a rebound in M&A volumes. We believe DWS is well-positioned with several funds in the market globally across equity and debt strategies. Investor sentiment is providing support that we are entering an attractive deployment window, particularly for transports where we are particularly constructive. In the U.S., growth across our infrastructure debt business is a testament to our ability to deliver truly differentiated strategies.
• Our Real Estate business is well-positioned for the next cycle, continuing to exhibit prudent active management and building on our strong track record. Critically, we have fully onboarded a new leadership team for U.S. Real Estate debt that will drive our targeted expansion strategy. Transaction volumes are picking up, fundamentals remain healthy, and peak interest rates should remove a key headwind. Investor sentiment continues to improve, underscored by increasingly positive capital formation discussions and reduced redemption queue Across Europe, performance is stabilizing after 2 years of correction, with strong occupier markets supporting positive NOI (Net Operating Income) growth and investment activity picking up following a slow start to the year.
• Opportunities continue to be borne by strong relationships: While the declining real estate market environment has exerted pressure in the most liquid pillar of our Alternatives business, we believe the worst is behind us. Our relentless focus on client engagement and consistent performance track record has helped us weather the choppiness that is a telltale characteristic of the bottom of a market cycle. We are grateful for the trust of our clients and seek to deliver strong alpha on their behalf. Looking ahead, we expect a normalization of real estate returns as rates stabilize, which should drive AUM (Assets Under Management) growth going forward.

Long-term goals require long-term vision, along with the unfailing discipline and unrelenting stamina to execute on a strategic plan. We keep this at the forefront of our minds as we put human and financial capital to work for you every day – change is inevitable, but growth is optional. Moving onwards and upwards, we do so with confidence knowing that our organizational culture and systematic approach to growing our Alternatives platform should help us as we seek to deliver more for you – our clients. Thank you for your continued trust throughout the process.

Sincerely,

Paul Kelly
Global Head of Alternatives