Future Returns: Resetting Investment Expectations for 2022

While economies across the world are strong, lofty valuations for public companies and the likelihood of interest-rate hikes mean investors are resetting their expectations for returns.

“This next phase of the economic cycle is definitely going to be slower than the record-breaking rally and pivot in the cycle that we saw over the last two years,” says Amanda Agati, chief investment officer for PNC Financial Services Asset Management Group. “We think it’s going to be a much tougher slog.”

Keep in mind, this more challenging outlook comes after a year when the S&P 500 index rose nearly 27%, capping a three-year period when the broad-market index was up more than 90%, according to Dow Jones Market Data.

For 2022, the S&P 500 is projected to gain 9%, which in a non-pandemic environment would certainly be considered a “home run for large-cap domestic equities,” Agati says. But relative to the last three years, it’s certainly lower.

When it comes to public debt, PNC is even more cautious. While the bank expects a “lower-for-longer” interest-rate environment to persist for the next several years, its economists do expect rates to move higher globally in 2022, putting price pressure on most categories of bonds.

In its 10-year forecast, PNC predicts the Bloomberg U.S. Aggregate Bond Index of intermediate-term corporate and government bonds will return 2.3% annually, while the Bloomberg Global Aggregate ex-U.S. Markets Index will return 2%.

The bright star for PNC across the “multi-asset universe,” Agati says, is alternative investments—private equity, private debt, and venture capital. “There are a lot more opportunities [in alternatives] for meaningfully additive returns relative to public markets going forward,” she says.

Penta recently spoke about these opportunities with Agati, who is responsible for the investment policies guiding PNC Private Bank and PNC Private Bank Hawthorn, which works with family offices. She also guides the investment policies for PNC Institutional Asset Management.

‘Innovation and Growth’

In a slower-growing world, Agati says investors are focusing on companies offering innovation and growth, “and they’re willing to pay up for it to a degree,” she says. They will find most of these opportunities are in private markets.

While nothing is “table-pounding cheap,” even in private equity, the return expectations are higher, mainly because of the premium investors receive by agreeing to lock up their money for longer. Private-equity funds typically have fixed terms of 10 years.

Investing in private equity, however, is a multi-year process, as the strongest portfolios are diversified collections of funds with different vintage years, meaning the date the funds begin to put capital to work. “Each vintage year is unique and diverse relative to the others,” Agati says.

Private-equity funds investing in 2022, for instance, are likely to be shaped by an increase in mergers and acquisitions, buyouts, and special-purpose companies fueled by “still unprecedented fiscal and monetary support,” the bank wrote in a first-quarter investment strategy report.

Funds investing this year also will be working against a backdrop of heightened stock market volatility and uneven economic growth—both of which could create pockets of opportunity.

“The ballast that private-investment strategies can bring in particularly volatile times—not being beholden to quarterly earnings calls and the drivers around updating guidance in an uncertain backdrop—can provide comfort in portfolios,” Agati says.

Life Sciences, Technology, and Crypto

For 2022, private equity themes worth accessing include life sciences, technology, and cryptocurrency.

Life sciences are a “real area of innovation and investment” that has been catalyzed by the pandemic. In technology more broadly, there’s a boom in innovation particularly related to the metaverse, or the creation of virtual worlds.

“The tech [sector] has really been able to use the pandemic to its advantage, pulling away from the pack, and continuing to invest and allocate capital and drive innovation,” Agati says.

More entrepreneurs this year also are likely to harness blockchain technology to develop new companies and products, opportunities that will likely be made available through venture-capital funds. This “could be a very interesting vintage year for some of those exposures to take hold,” she says.

Another theme that isn’t necessarily specific to 2022 as a vintage year is impact investing in local communities. “There’s this real homegrown feeling of responsibility and duty for those who are impact-oriented or responsible investing-oriented to try to find a way to have the impact in their own backyard,” Agati says.

Finding Opportunities in Fixed-Income

One potentially bright spot in public debt is emerging markets, which are driven by variables outside of U.S. Federal Reserve policy. PNC expects the Bloomberg Emerging Markets Aggregate bond index to return 6.2% annually over the next 10 years.

That is partly because of current valuation levels, but also because PNC expects low rates globally will drive demand for emerging-market debt. Also, lofty levels for commodities exported from emerging markets have made government balance sheets in many of these countries stronger, according to the 2022 outlook.

“The growth outlook for emerging markets in general is one of the brightest in the multi-asset universe,” Agati says.

Because individual countries could experience unexpected tensions or shocks, PNC recommends investors consider investing in this sector through actively managed funds. It’s definitely a place “where astute active managers can add value to tilt toward or away from benchmark exposures,” she says.

Wealthy investors also can consider private debt funds, which invest in below-investment-grade loans, mezzanine funding, and distressed or special situation funds, according to PNC. That’s because the drivers for privately issued debt are not as closely tied to the movement in interest rates as in public markets, Agati says.

That means the cost of capital for borrowers in private markets is relatively low, providing more runway for deal-making. “Even though parts of the private market cycle and the economic cycle are further along from the bottom of the pandemic, we don’t think the private debt cycle is there,” Agati says. “It just creates a more interesting opportunity for investors.”

But as with emerging market debt, investing in private debt is enhanced by active managers. That’s in part because managers can re-price their investments quickly in response to changing conditions.

According to PNC, “allocations to private debt may be among the first to benefit from opportunities that arise among rapidly growing industries looking for new sources of capital.”

As the war against Hamas dragged into 2024, there were worries here that investment would dry up in Israel’s globally important technology sector, as much of the world became angry against the casualties in Gaza and recoiled at the unstable security situation.

In fact, a new survey found investment into Israeli technology startups grew 28% last year to $10.6 billion. The influx buoyed Israel’s economy and helped it maintain a war footing on several battlefronts.

The increase marks a turnaround for Israeli startups, which had experienced a decline in investments in 2023 to $8.3 billion, a drop blamed in part on an effort to overhaul the country’s judicial system and the initial shock of the Hamas-led Oct. 7, 2023 attack.

Tech investment in Israel remains depressed from years past. It is still just a third of the almost $30 billion in private investments raised in 2021, a peak after which Israel followed the U.S. into a funding market downturn.

Any increase in Israeli technology investment defied expectations though. The sector is responsible for 20% of Israel’s gross domestic product and about 10% of employment. It contributed directly to 2.2% of GDP growth in the first three quarters of the year, according to Startup Nation Central—without which Israel would have been on a negative growth trend, it said.

“If you asked me a year before if I expected those numbers, I wouldn’t have,” said Avi Hasson, head of Startup Nation Central, the Tel Aviv-based nonprofit that tracks tech investments and released the investment survey.

Israel’s tech sector is among the world’s largest technology hubs, especially for startups. It has remained one of the most stable parts of the Israeli economy during the 15-month long war, which has taxed the economy and slashed expectations for growth to a mere 0.5% in 2024.

Industry investors and analysts say the war stifled what could have been even stronger growth. The survey didn’t break out how much of 2024’s investment came from foreign sources and local funders.

“We have an extremely innovative and dynamic high tech sector which is still holding on,” said Karnit Flug, a former governor of the Bank of Israel and now a senior fellow at the Jerusalem-based Israel Democracy Institute, a think tank. “It has recovered somewhat since the start of the war, but not as much as one would hope.”

At the war’s outset, tens of thousands of Israel’s nearly 400,000 tech employees were called into reserve service and companies scrambled to realign operations as rockets from Gaza and Lebanon pounded the country. Even as operations normalized, foreign airlines overwhelmingly cut service to Israel, spooking investors and making it harder for Israelis to reach their customers abroad.

An explosion in negative global sentiment toward Israel introduced a new form of risk in doing business with Israeli companies. Global ratings firms lowered Israel’s credit rating over uncertainty caused by the war.

Israel’s government flooded money into the economy to stabilize it shortly after war broke out in October 2023. That expansionary fiscal policy, economists say, stemmed what was an initial economic contraction in the war’s first quarter and helped Israel regain its footing, but is now resulting in expected tax increases to foot the bill.

The 2024 boost was led by investments into Israeli cybersecurity companies, which captured about 40% of all private capital raised, despite representing only 7% of Israeli tech companies. Many of Israel’s tech workers have served in advanced military-technology units, where they can gain experience building products. Israeli tech products are sometimes tested on the battlefield. These factors have led to its cybersecurity companies being dominant in the global market, industry experts said.

The number of Israeli defense-tech companies active throughout 2024 doubled, although they contributed to a much smaller percentage of the overall growth in investments. This included some startups which pivoted to the area amid a surge in global demand spurred by the war in Ukraine and at home in Israel. Funding raised by Israeli defense-tech companies grew to $165 million in 2024, from $19 million the previous year.

“The fact that things are literally battlefield proven, and both the understanding of the customer as well as the ability to put it into use and to accelerate the progress of those technologies, is something that is unique to Israel,” said Hasson.

Future Returns: Resetting Investment Expectations for 2022

What to expect from the year ahead.

The 28% increase buoyed the country as it battled on several fronts but investment remains down from 2021