On top of the illiquidity premium, private markets investments also offer some protection against panic, says Claire Madden, Co-Founder and Managing Partner.
These days, once rare geopolitical shocks seem to happen with alarming regularity, shaking public markets in the process. The war in the Middle East is the latest example in a long line of seismic events in recent years: less than a week on from the US airstrikes on Iran at the start of March, the FTSE100 had fallen 5.7%, erasing more than £150bn of value1. At times like these, it’s a sharp reminder that investors need a buffer against public market volatility as part of a diversified portfolio. Private markets investments can act as a relative haven of calm, smoothing out short term risk exposure and driving returns over the long term.
Illiquidity: long term performance plus panic protection
While the illiquidity of private markets has its risks because, unlike public markets where investors can sell stocks at a moment’s notice, investors in assets such as private equity are locked in for at least several years, tying up capital for longer has two major benefits:
- Long term performance: investors expect to be rewarded for holding their nerve with an “illiquidity premium” (i.e. a potentially higher rate of return) when they eventually exit the investment. This premium typically ranges from an extra 2-5%, according to an analysis by Barclays2
- Panic protection: during periods of turbulence, the structure of these investments prevents a wobble becoming a full-scale loss of confidence (and value). Since investment vehicles are close-ended, investors cannot withdraw their capital on a whim or in a panic during short-term bouts of uncertainty. This avoids the widespread stampedes for the exit that exacerbate swings in public markets. Instead, these structures allow time for the dust to settle on the wider economic or geopolitical situation.
In private equity for instance, investors and management teams are focussed on pursuing long term business growth, typically over a three-to-five-year period. While those companies may be positively or negatively affected by wider global events as they happen, their objective will be to continue with their strategic value creation plans. In a few years, or even months, the world may look very different from today, so they will be doing their best not to get derailed by immediate external events.
The rise of semi-liquid funds: a panacea?
Some investors may baulk at the prospect of tying up a portion of their capital for so long, and semi-liquid long terms asset funds (LTAFs) have been touted as a “best of both worlds” solution by providing access to both public and private markets in one, and offering instant liquidity. However, their promise to allow investors to withdraw capital on demand may not be the panacea it first appears.
These are open-ended vehicles, so a widespread rush for the exit could conceivably occur if enough investors get sufficiently spooked. However, if too many try to redeem their capital at once, there are serious questions about whether these funds would fully pay out, given the illiquid nature of many of their investments. This risk has recently been illustrated by alternative asset manager Blue Owl, which curbed investors’ ability to withdraw capital from a private credit fund3, and BlackRock’s decision to cap redemptions from a flagship fund in response to growing redemption calls from investors.4 Moreover, those that do withdraw their money early won’t benefit from the illiquidity premium.
Investors may be better off opting for standalone public markets investments for liquidity and private markets for the illiquidity premium when constructing a balanced portfolio. They can’t necessarily hope to do both successfully in one vehicle. Accessing the latter is now easier for private capital investors thanks to models like ours.
An alternative to turmoil
It’s possible that private markets deal volumes may be impacted by the current global environment as investors pause to take stock of the situation, but that’s not to say that good investment opportunities won’t arise amid the turmoil. Private capital in particular is usually able to be nimble to seize them when they appear.
Private markets really come into their own during times of turbulence – not just because they offer an alternative route to returns to traditional public markets, but because their gated structure prevents panic taking hold and redemptions running wild. As a strong performer in their own right, they deserve a prominent place in investors’ portfolios at any time, but as unpredictability becomes the norm, the case for investing in private markets as a hedge against volatility becomes more compelling than ever.
What are the risks in investing in private markets?
Investments in private markets carry significant risks including illiquidity (investments should be considered as medium to long-term holds); potential concentration risk requiring careful diversification; performance variability between managers and vintages; and potential total loss of capital. Company performance can fluctuate substantially, and unlike public markets, investors cannot exit positions quickly when circumstances change. Therefore, Investors should bear in mind that there are no guarantees of returns, they may not be protected if something goes wrong and they should not invest unless they are prepared to lose all of their money.