Assessing private markets

Estimated reading time: 2 minutes

Private markets cover a huge range of assets as they include, by definition, any asset that is not traded on a public market.  A key difference between the private and public markets is the level of illiquidity and complexity, with private assets typically being less liquid and more complex than their public counterparts. 

Private markets have been an area of increasing interest for pension schemes over recent times as trustees recognise their schemes have a pool of assets that could, in part, accept the illiquidity and benefit from the higher returns that can accompany it.

They are also a diverse asset class with a number of sub-sets, all with their own specific risk and return characteristics – for example private equity, private debt and infrastructure all have different investment characteristics. 

Therefore, when assessing private markets and their appropriateness for your scheme we believe the first step is to consider the role they will play in the scheme’s portfolio.  Depending upon the section of the market you are considering there are a range of roles that private assets could play:

  • Cashflow: the debt factions of private markets are still able to distribute relatively high levels of income to investors (in excess of .5% p.a.), which can help pension funds meet cash flow requirements.
  • Diversification: private markets can provide diversification benefits in a wider portfolio, given the low correlations many of the asset classes possess with traditional asset classes.  Care is needed here as, for example, equity risk is not diversified away by investing in a private company; hence private equity is a poor diversifier to public equity.
  • Return enhancement: Parts of the private markets have the ability to target enhanced returns compared to traditional asset classes. This can arise from the extra complexity of these assets and hence due diligence requirements that will deter many investors, or from the inherently higher leverage and risk associated with some private assets.

Not one private asset can tick all three boxes highlighted above.  

" it is key for investors to define the “problem they are attempting to solve”"

Hence it is key for investors to define the “problem they are attempting to solve” before starting to explore whether an allocation to private markets can improve their strategy. 

Where we are seeing most interest by pension schemes is for those cashflow producing assets.  This naturally leads us towards the credit parts of the market, such as Direct Lending, Real Estate Debt (Commercial and Residential) and Infrastructure (Debt). 

We are also seeing interest from small and medium sized schemes for Illiquid Multi-Asset funds (those that invest in debt and equity within private markets) or Illiquid Multi-Asset Credit (those that invest in debt within private markets only) as a governance solution for accessing the more complex private markets without placing a significant extra burden on the trustee board.

Our general stance, given the extra complexities that come with investing in this area, is that if you can achieve all your strategic objectives by using public markets then there is not the need to go to private assets.  However, for many schemes where they are looking to continue to work assets hard to close funding gaps, private assets are playing an increasing role.