Private markets have gained significant attention recently due to their potential for higher returns and long-term investment opportunities, despite challenges such as illiquidity and increased risks. The latest blog from CJ Cowan explores the advantages and drawbacks of private market investments, their growing popularity, and considerations for retail investors.
Private markets are so hot right now. Schroders launched the UK’s first LTAF (long-term asset fund) in 2023 and other asset managers have followed suit. As investors increasingly allocate to low fee passive funds, squeezing profit margins at asset managers, it is understandable why these higher fee products are so popular with sales teams. This is not just driven by asset managers trying to make money though, Rachel Reeves wants 10% of pension assets to be invested in private markets by 2030. It feels like many people think the fact an investment is private automatically makes it a good one, but is the hype worth it?
[For the uninitiated, ‘private markets’ mean direct investment in companies, be that equity or debt, as opposed to buying listed shares (equity) or bonds (debt) that can be freely traded on public markets. The most pronounced difference is that you can’t easily sell it, but by sacrificing liquidity you can achieve higher returns.]
There are a lot of pros that come from investing in private markets. In the case of venture capital, it gives you access to early stage, high growth companies which could go up 10x, or even 100x.
These days, companies stay private for longer too. In 2013, when the term ‘unicorn’ was coined – referring to a private company worth >$1bn – there were only 39. Still more common than actual unicorns, but it’s now estimated that there are more than 1,500 worldwide, comfortably more than the world’s mountain gorilla population!
Other benefits include not having to incessantly focus on beating the next quarter’s earnings estimates, allowing management to think long-term. The biggest equity investors often receive a seat on the company’s board too, so they have more influence in running it. Although maybe the most significant pro is ease of taking on debt to boost returns.
A final reason many are drawn to private markets is reduced price volatility. As you can’t openly sell (or buy) shares in private companies, investors need not contend with the price swings inherent in liquid stock and bond markets.
This is nice. It is easier to stay invested when the value of your investment is only reviewed quarterly, doesn’t go down when stock markets do, and if you can’t sell it anyway. It feels less risky, even though it isn’t.
There is something to watch out for though. By giving up liquidity you should expect a higher return, but there is a growing body of research that suggests many investors like the illusion of stable asset valuations so much that sometimes you pay even more for the illiquidity that leads to these stable prices.
The growth in private markets over the past decade has been stratospheric and it is expected to continue. But as with any asset class that sees stonking inflows, you can end up in a situation where too much money is chasing too few (good) opportunities.
Investors stop being as discerning and lending standards drop, as can be seen from two high profile frauds last year – Tricolor and First Brands. A fund manager we met with shortly after the allegations surfaced quipped that anyone doing an ounce of due diligence should not have been anywhere near either of these companies.
Meanwhile, the era of cheap money is over. It is too expensive to borrow extensively to buy out companies and, if you do, then returns must be delivered a lot quicker than in the 2010s.
All of this means institutional investors, many of whom have uncomfortably large private market allocations, may well have increasingly low-quality assets as well. Going public is not paying these investors out what they think their assets are worth, so they need someone else to sell to. Enter, the retail investor.
It is very noble for existing investors in private assets to share the spoils with the wider populus, but are we really democratising finance, or just offloading risk onto unsuspecting dumb money so they are left holding the bag?
There is no doubt there are phenomenal investment opportunities in private markets, but it is hard to believe the ones that make it all the way down to the lowly retail investor are the best of the best. However, we know that the difference between the best and worst private equity managers is much bigger than in public markets, so investing with a top-tier manager with great access to deals may mitigate some of this negative selection bias.
While it is important to be a little cynical, the positives of private markets are very real, and the most highlighted drawback, illiquidity, should not be a concern if you are investing your pension. Depending on how old you are now (and how high the retirement age is when you get there) you may well have an investment horizon spanning several decades.
For multi asset funds that offer daily liquidity, like the ones we manage, investment vehicles like LTAFs aren’t necessarily appropriate as we need to adjust allocations quickly when we have in or outflows. We would typically access private assets through investment trusts, which can be freely traded. You lose the benefits of stable prices, but that is just an illusion anyway.
As a wholly separate investment, and if you can get comfortable that you really will not need the money for 10 years or more, then private markets are certainly worth considering. Just remember, private doesn’t always mean better, it just means private.
CJ is a portfolio manager of the Quilter Investors Cirilium and Monthly Income Portfolios. CJ joined Quilter Investors in August 2018 from Aberdeen Standard Investments where he worked in the global macro team, managing global government bond and global aggregate portfolios.
CJ is a CFA charterholder and has also completed the Chartered Alternative Investment Analyst qualification. CJ has a degree in economics from the University of Bristol and an MPhil in Economic and Social History from Brasenose College, University of Oxford.
