Home / Analysis / More transparency, less crowding needed in private equity

Institutional investors love private equity but it's bringing them down. They're sweating everything from valuations to overcrowding and "private equity bubble risk".

Private equity will remain the top alternative asset class for the next two to three years, according to a State Street survey of 480 institutional investors, including asset and private market managers, insurance companies and asset owners from North America, Latin America, Europe and the Asia-Pacific. Private equity/venture capital will also see the biggest increase in allocations, though with infrastructure a winner on a net basis.

“The tailwinds of the last decade may be gone, but it is clear that private markets remain extremely attractive,” said Paul Fleming, head of the global alternatives segment for State Street (picture at top). “Our survey finds that three quarters of respondents believe tougher economic conditions will create discounted opportunities, but investors are likely to bide their time, as at least half feel valuations have not yet fully adjusted. Dry powder will become invaluable in the next couple of years.”

Marring the otherwise optimistic topline findings are the reservations those 480 institutional investors hold about private market assets – like the above mentioned fact that half of respondents are worried that private equity valuations are yet to adjust to the new market (only 39 per cent of private market managers themselves share that concern). They’re also worried about overcrowding and competition for deals as new money floods into the space, and “private equity bubble risk” generated by the falling revenues and profits of companies going public.   

Respondents are in broad agreement that higher rates will make highly leveraged private assets less appealing; that will also make traditional fixed income more appealing, potentially cooling interest in private debt. However, institutions will keep allocating to private markets in line with their targets and mostly see them as good long-term investments, and only 21 per cent of respondents said they would not make any more investments in private markets until they “have a clearer view of how long inflation will last”.

The major concerns mostly arise from the new frontier. Big private markets managers have been turning to retail/wholesale investors for new money as the defined benefit pension market declines and pension funds generally reach the limits of their allocations to illiquid investments. But most respondents to the State Street survey believe there’s a “need for more transparency” in private markets to make them suitable for retail investors – and more than half of respondents believe that the inherent complexity and lack of transparency in private market assets makes them unsuitable for retail investors and defined contribution pension members.

However, the attention of regulators who are forced to act by an influx of retail money and “digital fractionalization” of private markets assets would go some way to balming this fear.

“Private market managers are quite bullish on tokenization going mainstream in the next three plus years, as they look to widen their investor base,” Fleming said. “However, democratization will place fresh demands on private market managers from a regulatory and transparency perspective. The majority of managers believe regulators will be compelled to introduce more stringent reporting requirements as retail participation rises. It is critical for private managers to enhance their data management, which will help them reach the next stage in their growth.”