The trend towards private markets investing in 2017 has been well covered by the trade press. With 98% of U.S. companies controlled by private capital and average returns from public equities in the UK and Europe estimated by McKinsey Global Institute* to be in the region of 4 - 6.5% for the next 20 years, the question that’s legitimately asked is, ‘why has it taken so long for institutional asset owners to wake up to private markets potential?’.
Historically the answer lay in risk adjusted returns simply not matching up, the introduction of conservative capital solvency rules for pension plans and insurers, plus linked to that, the lack of liquidity on offer in private equity and hedge funds.
However, new innovative fund structures from a variety of asset managers and a realisation that even moderate rate risks over the next few years won’t make a significant enough effect on the cash flow crises they face, has pushed many investment officers to look again.
Regulators must also be given some credit. At our recent ‘Insurance Asset Management Summit’ in London on the 16th November, Lewis Webber, Head of Data Analytics at the Prudential Regulatory Authority was quoted as saying, “Insurers, with long-dated predictable liabilities like annuities, are well placed to hold illiquid assets”.
Access to private markets has got significantly easier for asset owners. With a broadening of the multi-asset class theme, many third-party managers are offering exposure as part of pooled, pre-packaged solutions, presenting ideal access to the asset class.
Private markets however have yet to face a serious crucial test, that of liquidity in a stressed market. Should a certain U.S. President be indicted or start a debilitating trade war with China, Brexit negotiations become seriously unhinged or a major terrorist event hit vital public infrastructure, then the all to real possibility of a rush for the door could materialise in private markets. Redemptions on such a scale could overload the system, unless the well-reported large capital buffers of multi-national organisations reassure investors to hold fire and interest rate payments keep coming. Ultimately, pension plans and insurers are more concerned in the short term with cash flow to pay their liabilities, so large swathes of private debt being held by such long-term investors, as opposed to retail, could do al lot to avoid such liquidity squeezing scenarios.
The much hyped push for private sector investment, as touted by former chancellor George Osborne, finally appears to be materialising on a consistent level.
The next step, likely still a few years off, will be for the appetite for private investing to trickle down to SMEs. Such a move would undoubtedly be hugely positive for employment and social mobility of the less well-off.
Private markets are firmly in the spot light and the economic benefits are real. This is good news for as long as it continues.
The Investing in Private Markets, Europe 2017 report has recently been released and can be downloaded for free here.