Since the emergence of “Modern Portfolio Theory” and the “Capital Asset Pricing Model” in the late 1960s, institutional investors have taken a quantitatively driven approach to portfolio construction, looking to create portfolio diversification and obtain better risk-adjusted returns by balancing their asset-class exposures. This journey has seen several important advancements in thinking about how to optimally achieve desired results.
Funds that want to take the total portfolio approach first need to get the total portfolio view. To do that they not only need data – and lots of it – but a rock-solid understanding of exactly how they’re going to use it.
Why pessimistic private markets predictions haven’t come true (but monthly valuation will)
Private markets have a mixed reputation – at least in Australia. Super funds love them for the fact that they can soak up hundreds of millions of dollars and turn them into billions of dollars, but their members and regulators wonder if they know how much the assets are really worth. The reputation isn’t entirely undeserved, says Juan Delgado-Moreira, one of the newly appointed co-CEOs of international private markets manager Hamilton Lane.
“We are an expensive asset class that is relatively small and obscure but which is growing fast, and the level of transparency that we’ve provided to the broader market has not been adequate,” Delgado-Moreira tells ISN. “When you combine those things it’s normal that the end clients demand more transparency and more scrutiny, particularly given what’s going on in markets: we’ve gone through a period of high volatility and mini-bubbles, and private markets have been in a number of those.”
The desire for more frequent valuations has seen the growth of open-ended evergreen funds, which are picking up market share and which have periodic redemptions build into them. That’s going to put pressure on the rest of the industry, Delgado-Moreira says, and the client experience with evergreen funds has been “very positive”.
“That’s the leading edge of where broader parts of the industry are moving towards. Yes investors bear that cost, and yes they will demand that, with economies of scale, that cost will come down over time. But that’s a monthly mark.”
A monthly fundamentals-based third-party valuation seems like a pretty good deal. But the demand for more frequent private market valuations never seems to be sated. Daily valuations? It might be possible with a mark-to-model approach – but while that will give you a valuation, it’s unlikely to be a transactable one.
“Frankly, you’d be trading something that is inefficient in carrying data quickly for a black box algorithmic challenge – and I don’t think we’re better served by going down that path, and that’s probably why the industry hasn’t pushed for it. It’s very easy to program models, even before AI,” Delgado-Moreira says. “You can mark-to-model anything you want in private markets; the reason it hasn’t developed is because what do we get? Nothing really valuable.”
Still, the lack of more frequent valuations has done little to kill the appetite for private markets assets from big super funds with member bases in the accumulation stage. They’ve been leaders in infrastructure and property investing, savvy private equity investors and are now hoovering up capacity in private credit funds. That doesn’t mean it’s all smooth sailing.
“In some areas I think they will express frustration. The first time I went to Australia, in 2006 or 2007, the prediction was that fees would be down to 50 bips in the whole asset class. Those predictions of margins coming down and the private markets becoming more like the public markets have not come true.”
But while the dream of 50 basis point fees remains just that, the market has never been two and twenty for everybody – and rarely for an Australian super fund. There are economies of scale; size drives significant discounts.
“Now they’re testing whether there can be economies of scale on secondaries, whether there can be economies of scale on credit; can we do that in other parts of the private markets?”
Delgado-Moreira sees the year ahead as being full of “predictable surprises”, including more activity coming through on the buyout side and record fundraising in credit, as well as private markets in general holding up well in the face of sustained macroeconomic pressures.
“While these markets can be below par in terms of investment pace for a while, when the numbers are tallied up at the end of the year I don’t think 2023 will turn out to be such a horrible year in terms of volumes… It’s been below trend, but it’s not going to be much behind what 2018 was.”
“That’s okay; people don’t listen to us when we say we came off absolute records – record exists, record returns. You go from a record to ‘Oh it’s horrible, it’s the worst ever’. By nearly any measure it’s not the worst ever. We’ve had similar corrections before.”
