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Chief Investment Office

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Investing in private markets

Taking the long-term view

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Investors must be mindful of the risks inherent in private markets including illiquidity, longer lockup periods, leverage, concentration risks and limited control and transparency of underlying holdings. While risks cannot be fully eliminated, it is possible to mitigate them through extensive due diligence and strict manager selection, and by diversifying across vintage years, strategies and geographies. See also the more detailed section on risks at the end of the page.

Private markets is an umbrella term for assets that are not traded on public exchanges. Investors in private markets face a wide menu of options in terms of asset class, investment strategy, or mode of investment. We think it has become increasingly important for investors to consider exposure to private markets. In our view, private markets offer a combination of high potential returns, a long-term focus, and access to innovative and fast-growing businesses.

How investors should think about private markets in their portfolio.

We believe that alternative investments should be a key component of long-term portfolios for those investors that are willing and able to bear their unique risks. Investors considering putting money to work in private markets for the first time can consider the three following steps:

Construct an investment plan. As a general rule, holding up to 20% of a liquid portfolio in private assets should enable investors whose plans allow for illiquid private assets to avoid running short of cash, including in periods of market stress. This allocation may rise up to 40% if an investor has modest cash flow needs of their portfolio and/or can draw on liquidity from another source.
Consider how to adapt this investment plan for particular financial needs. Investors whose primary need is to raise income from their investments may want to consider income-bearing assets that do not add excessive volatility to portfolios. These can include private debt, private real estate, and private infrastructure with most likely only a modest allocation to private equity.
On the other hand, investors whose main aim is to grow the value of their wealth through rising capital values could aim to generate higher returns from a long-term portfolio focused on private equity strategies. An all-public equity investor could fund their private equity allocation one-for-one from listed stocks.
Consider how consistency impacts overall private market portfolio allocations. The different mechanics between public and private markets mean investing in the latter may require a commitment to invest continuously and in a diversified manner in order to reach long-term allocations.
Initial investments may focus on private market approaches that allocate money to multiple managers for diversification purposes. Investors may also consider so-called evergreen or perpetual capital approaches that are fully funded from day one and invest in existing assets, as opposed to traditional capital call approaches where money is called from investors but not be invested until some time after.

The outlook for private market investments

What are the most attractive opportunities in private markets? Are private credit a source of concern? Is the distribution environment improving for private markets? Twice a year, our Deep Dive – Private Markets Outlook video series will update you on the latest developments in private equity and broader private markets, and where we see the best opportunities.

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With the fed rate cut cycle beginning and volatility picking up in public markets, we think it is important to maintain a long-term view and allocate to private assets in a portfolio.

For those investors who can tolerate the illiquidity required to invest, private assets can help investors build a portfolio that is more diversified and that has the potential to generate higher risk-adjusted returns.

First, incorporating private assets can provide access to investment opportunities which are simply unavailable in public markets. Second, historically, investors have been rewarded for their patience with higher returns. For instance we estimate private equity to outperform public equity by about 2% per year over this economic cycle.

And it’s not just about returns. Some strategies can bring an element of inflation hedging to a portfolio, which remains a lingering concern in many markets.

Our view on private markets in 2024:

In private equity, we currently seek exposure to value-oriented buyout strategies and continue to recommend allocations to secondaries.
In private debt, we think return prospects still look attractive. While there are risks, we believe these are manageable and recommend focusing on areas with strong fundamentals and prefer senior, upper middle market, and sponsor-backed loans.
In real assets, we continue to see private real estate as a diversifier and believe the sector could start reaccelerating next year, depending on the interest rate cycle and the health of the global economy. We see infrastructure assets as attractive, especially those supported by government stimulus and benefitting from inflation-hedged and resilient cash flows.

Download the full report

General

Private equity

Secondaries. Seasoned and quality assets at a discount

pdf, 546 KB

Private debt

Real assets

What are the risks of investing in private markets funds

Investors in private market funds must consider the following risks. Many of these factors can actually work in investors' favor as long as expectations of investors and managers are set properly in advance.

Illiquidity. When investing in a private markets fund, investors must be prepared to accept significant illiquidity. This illiquidity is what allows access to more inefficient markets. On the other hand, investors cannot expect to access their capital or receive distributions with any regularity. Their only potential option for liquidity is to try to sell their stakes in the secondary market, where there may be no bid at all, or they may have to sell at a significant discount to fair value, if the fund manager even permits.
Uncertain cash flows. Amount and timing of the cash flow is at the manager‘s discretion. LPs need to fund a “capital call” within a certain time frame. Unpredictable cash flows apply to early stage capital calls as well as to distributions to investors at later stages
Fees. Private markets fund managers charge both management fees (typically in the 1.5-2.0% range) and incentive fees (typically in the 15-20% range). These levels are high compared to traditional asset funds, but the incentive fee helps to align objectives as the manager only gets paid if the investor achieves attractive returns. Most funds specify a hurdle or preferred return below which the manager does not receive incentive pay.
Lack of control: Investors in private market funds cede control over investment decisions, pace of investments and exits, strategic and operational matters, and other significant decisions to the third party fund manager. While this eliminates investors' ability to "vote with their feet" to express displeasure with the manager, ceding control gives the manager the necessary tools to seek outperformance for investors.
Blind pool risk. Investors must make long-term commitments to private markets funds in advance, without knowing what the underlying investments will be. This is known as blind pool risk. This dynamic can be mitigated through familiarity with the general partner and its track record as well as proper due diligence.
Limited disclosure. Disclosure on performance of underlying investments is periodic and can be more limited given that managers need time and flexibility to work with underlying companies and are focused on long-term value creation. Also, valuation of private assets involves subjectivity and assumptions, and as such may not necessarily be indicative of long-term performance or potential.
Use of leverage. This is not a blanket risk. Certain private markets strategies such as buyout use significant leverage which poses potential default risk if the company encounters stress, but many PM strategies do not involve any leverage. Prudent leverage in the right situation has historically shown to help enhance returns without significant incremental risk.

Non-Traditional Assets Disclaimer

Non-traditional asset classes are alternative investments that include hedge funds, private equity, real estate, and managed futures (collectively, alternative investments). Interests of alternative investment funds are sold only to qualified investors, and only by means of offering documents that include information about the risks, performance and expenses of alternative investment funds, and which clients are urged to read carefully before subscribing and retain. An investment in an alternative investment fund is speculative and involves significant risks. Specifically, these investments (1) are not mutual funds and are not subject to the same regulatory requirements as mutual funds; (2) may have performance that is volatile, and investors may lose all or a substantial amount of their investment; (3) may engage in leverage and other speculative investment practices that may increase the risk of investment loss; (4) are long-term, illiquid investments, there is generally no secondary market for the interests of a fund, and none is expected to develop; (5) interests of alternative investment funds typically will be illiquid and subject to restrictions on transfer; (6) may not be required to provide periodic pricing or valuation information to investors; (7) generally involve complex tax strategies and there may be delays in distributing tax information to investors; (8) are subject to high fees, including management fees and other fees and expenses, all of which will reduce profits.

Interests in alternative investment funds are not deposits or obligations of, or guaranteed or endorsed by, any bank or other insured depository institution, and are not federally insured by the Federal Deposit Insurance Corporation, the Federal Reserve Board, or any other governmental agency. Prospective investors should understand these risks and have the financial ability and willingness to accept them for an extended period of time before making an investment in an alternative investment fund and should consider an alternative investment fund as a supplement to an overall investment program.

In addition to the risks that apply to alternative investments generally, the following are additional risks related to an investment in these strategies:

Hedge Fund Risk: There are risks specifically associated with investing in hedge funds, which may include risks associated with investing in short sales, options, small-cap stocks, “junk bonds,” derivatives, distressed securities, non-U.S. securities and illiquid investments.
Managed Futures: There are risks specifically associated with investing in managed futures programs. For example, not all managers focus on all strategies at all times, and managed futures strategies may have material directional elements.
Real Estate: There are risks specifically associated with investing in real estate products and real estate investment trusts. They involve risks associated with debt, adverse changes in general economic or local market conditions, changes in governmental, tax, real estate and zoning laws or regulations, risks associated with capital calls and, for some real estate products, the risks associated with the ability to qualify for favorable treatment under the federal tax laws.
Private Equity: There are risks specifically associated with investing in private equity. Capital calls can be made on short notice, and the failure to meet capital calls can result in significant adverse consequences including, but not limited to, a total loss of investment.
Foreign Exchange/Currency Risk: Investors in securities of issuers located outside of the United States should be aware that even for securities denominated in U.S. dollars, changes in the exchange rate between the U.S. dollar and the issuer’s “home” currency can have unexpected effects on the market value and liquidity of those securities. Those securities may also be affected by other risks (such as political, economic or regulatory changes) that may not be readily known to a U.S. investor.