Important insights for wealth managers: Navigating the complexities of private markets 

Private markets provide access to unique return streams, illiquidity premiums, and exposure to sectors not accessible through public markets. Investing in private markets demands a new mindset, skills, and a long-term perspective. Wealth managers must understand the structural and behavioral differences that set private markets apart from public strategies. Here are five crucial insights to consider before making private market allocations.

Investing in a private markets fund is not akin to purchasing shares on an exchange, where funds are fully deployed immediately. Instead, capital is “called” over time as investment opportunities arise. This staged deployment can be frustrating for clients who expect immediate exposure. Some funds call capital quickly, while others take years. Distributions might come as a single lump sum or trickle in slowly. Understanding these dynamics is crucial for maintaining liquidity, avoiding forced sales, and meeting client spending needs. Wealth managers should employ pacing models to strategically plan commitment amounts, timing, and vintage years. Without careful pacing, private market portfolios can easily swing from being underexposed to overcommitted, leaving little room for flexibility. We assist wealth managers navigate this challenge through sensitivity analyses focused on specific commitment targets, helping them prepare for unexpected changes.

Private funds often experience negative returns in their early years due to capital deployment, management fees and delayed exits. This phenomenon, known as the “J-Curve”, can be disorientating for clients accustomed to regular growth from public investments.  It is important for wealth managers to understand the various J-curve mitigation strategies, including credit facilities, management fee restructuring, secondaries, co-investments and semi-liquid funds.

Sharp declines in public markets can make private markets holdings appear disproportionately large within a portfolio, known as the “denominator effect”. This may push clients beyond their target allocation to private assets, leading to allocation imbalances. Over-allocation can also occur when private equity funds draw capital faster than expected or when distribution rates fall short, potentially leading to increased cash outflows. We support wealth managers by providing tools to continuously monitor allocation levels and develop contingency plans for sudden changes, helping ensure clients remain on track even during market volatility.

One of the most challenging aspects of private markets is the delay in obtaining detailed portfolio information typically found in a private market fund’s quarterly report. Unlike public markets, where positions and valuation changes can be reported almost immediately, private market valuations may take several months to be communicated. Private market funds generally provide quarterly reports to their Limited Partners (LPs), but they must first gather financial data from their portfolio companies. This process can lead to LPs receiving their quarterly statements 2-3 months after the quarter ends. Additionally, fourth-quarter reports often face even longer delays due to annual audits and potential third-party valuation reviews. This delay can result in LPs having an incomplete understanding of their portfolio’s exposure to private market assets and any changes in valuations. The lag in receiving portfolio information complicates the determination of actual asset allocation, and the challenge intensifies as the allocation to private markets increases. To effectively address reporting lags in private markets, wealth managers should implement a robust strategic portfolio plan, seek to enhance manager selection processes, maintain strong communication with fund managers, and educate stakeholders on the unique characteristics of private market investments.

Building a private markets program typically involves investing in new funds annually. This strategy allows wealth managers to access a continuous stream of investment opportunities tailored to specific industries or regions. By regularly committing to new funds, managers can stay aligned with market trends, potentially capture emerging opportunities, and leverage fund managers’ evolving expertise. We assist wealth managers in implementing programmatic investment strategies that balance risk and opportunity, helping ensure diversification across vintage years to minimize exposure to any single economic cycle and seek to enhance long-term portfolio resilience.

By understanding these key aspects of private markets, wealth managers can better navigate this complex landscape and make informed decisions that align with their client’s investment goals.