Private markets have seen huge growth over the past two decades, going from a relatively niche part of the industry to a dominant asset class. McKinsey’s private markets report₁ set the size of the industry at more than $13trn (£9.9trn) in June 2023 up from around $3trn (£2.5trn) in 2012.
There are many reasons for this growth: the dis-intermediation of banks as capital providers post-2008, the reach for yield in the zero interest rates era, the sale of state infrastructure assets and the tendency of companies to stay private longer.
Some of it is a push from fund managers and consultants to retain higher fee products and services in the face of large-scale moves to passive management in listed markets.
Private markets aren’t a coherent asset class, they are a grouping of private equity, venture capital, infrastructure equity, real estate equity and private debt, which all have different characteristics.
Private markets bring the promise of investing in a new hot wave of startups or being one of a small group of investors in a lucrative infrastructure deal. But the reduction in transparency can lead to a host of issues that can cancel out those opportunities if investors are not careful.
One issue has always been that fees charged by managers can eat up all of the additional advantage of the underlying assets and this is not appreciated as much as it should be. The traditional fee models in some parts of the private markets need to change.
The so-called illiquidity premium is not a given and is hard to pin down in practice. The future expected returns of private markets assets – like all financial markets – are not knowable to any degree of certainty and any analysis of the benefits of private markets to members depends heavily on the assumptions chosen.
Even when looking at actual returns data, the practice of focusing on the frequently misleading internal rate of return can give investors the wrong impression.
Some academics believe data shows that the global buyout market has not outperformed listed equities since about 2005₂&₃.
Private markets are frequently put on a pedestal that isn’t deserved.
On the other hand private equity founders have become staggeringly wealthy – 22 of the Fortune 400 list in 2021 came from the private markets industry. There is plenty of money to be made selling and running private markets funds, nothing inherently wrong with that, but are they sharing the returns fairly with their investors. This was a concern that held us back from signing the Mansion House Compact.
As they grow, large-scale asset owners are able to address this by designing their own programs, utilising in-house teams and making the most of direct deals and co-investments to access private markets in a way that leaves a fair share of economics in the hands of their members, but this takes scale as we have seen in the Australian and Canadian pension markets.
For our part, as we are looking ahead to being £50bn in a few short years, we are now approaching sufficient scale to do this efficiently as are some other UK master trusts.
Our custodian model also gives us the flexibility to structure these investments in the best way for the underlying assets, rather than being limited to funds that are frequently structured sub-optimally so they can be held on platforms.
We are advancing work with commercial asset managers as well as asset owner peers with a view to putting top-class proposals in front of our trustees at the right time, to allocate a portion of our assets to private markets in a way that will deliver value to members’ pensions and allow us to preserve our low charging structure.
The way we look at these investments is as a hurdle rate to the global listed markets. We know we can get our members exposure to global listed markets for low fees, so to put real value into the hands of members we need to do better than this after fees. We also want to see asset owners being a stronger and more influential force collaborating together, rather than competing against each other.
Such investments could represent billions of pounds of new growth capital invested into UK infrastructure and real estate, among other things. Perhaps building the wind farms, batteries and data centres of the future?
Notes and references
1) Global Private Markets Review 2024 | McKinsey
2) An Inconvenient Fact: Private Equity Returns & The Billionaire
Factory by Ludovic Phalippou 2020
3) “Patient Capital” Josh Lerner, Victoria Ivashina
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