Private conversations: managing expectations for unlisted assets 

Investors face distinct structural complexities when allocating to unlisted assets such as private equity: capital is called over time, returns can be negative in the early years, valuations typically lag, and the denominator effect can result in a portfolio overweight to the sector after a public (equity) market drawdown. Those closest to analysing private market opportunities understand these features. But that understanding is not always translated into clear expectations for the broader governance chain – investment fund sponsors, boards, internal stakeholders and end-investors - and that communication gap risks undermining private market programmes.

Public market allocations provide an immediate feedback loop. Daily pricing gives investors a constant read on portfolio value and, by extension, on performance. Investors become familiar with that rhythm and judge managers against it.

Private markets break that feedback loop. Quarterly valuations typically publish two to three months after quarter-end. In closed-end funds, the early “J-curve” experience - negative reported returns while fees are charged and capital is being deployed - is common. Observers more attuned to assessing public markets can interpret an early down-period as underperformance rather than an expected phase of value creation. That misinterpretation can lead to pressure to halt commitments at precisely the point when patient capital is required, particularly when the aim is to build out diversified exposure across multiple vintages over time.

Establishing clarity around the mechanics before commitments are made can preserve allocations through the cycle. The conversation matters because governance decisions made as the exposure builds towards maturity can determine whether or not a programme captures the illiquidity premium private markets offer.  

A characteristic of private markets is that stable or slowly moving valuations can reflect, in effect, lagged information. When share markets are running hot, private market valuations will often not keep pace - evidence of economic gains tends to materialise over time, and sometimes with a “pop” as individual company exits are completed.

The opposite is also true. During the 2022 public market drawdown, many private equity funds reported steady or modestly positive valuations while listed equities fell sharply. That divergence did not necessarily indicate outperformance; it often reflected appraisal-based valuation timing, the later incorporation of market signals, and differences in liquidity and operating performance.

When delayed markdowns arrived, stakeholders who had interpreted earlier steady valuations as evidence of strength were confused. Others who both expected and recognised the lag were better positioned to assess the programme’s true performance. Both outcomes can lead to a governance failure arising from expectations not being clear at the outset.

Effective private markets communication shares a number of characteristics. It is proactive - framed and delivered before commitments are made, not in the event of adverse signals. It is specific - not merely “returns may be negative early,” but rather “this commitment will likely show a negative net Internal Rate of Return (IRR) in years zero–two as deployment and fees precede exits; this pattern is consistent with the strategy’s normal earning cycle.” And it reframes evaluation away from short-term mark-to-market returns to the metrics that matter in private investing.

Those metrics include:

• Pace and quality of capital deployment relative to the fund’s target strategy and vintage expectations.
• Operational progress in portfolio companies and key value-creation milestones.
• Realised cash flows: distributions to paid-in capital (DPI) and distribution patterns versus expected timelines.
• TVPI (total value to paid-in) and net IRR over appropriate horizons, with vintage-year and strategy context.
• General Partner alignment indicators: co-investment, fee structures and follow-on reserve policies.
• Portfolio construction signals: concentration, exposure to cyclical sectors and diversification across vintages.

These measures are harder to convey than a single trailing return, but they are the signals that indicate whether a programme is functioning as intended. Stakeholders who are equipped with a grasp of this framework are better able to tolerate short-term reporting volatility or downturns and therefore make decisions consistent with long-term objectives.

Timing matters. Before a commitment is imminent, committees and end-investors tend to be most open to learning rather than seeking confirmation for a decided course. Once capital is called and potentially subdued returns appear, the same explanations can be perceived as defensive. An understanding of an appropriate monitoring framework in the planning and approval phase positions fiduciaries to make disciplined allocation decisions.

Governance protocols should codify these expectations: pre-commitment briefings, monitoring dashboards that reference the metrics above, and broad guidelines for when deployment or performance deviates materially from reasonable assumptions. When investors understand the typical lifecycle of a private investment - deployment, value creation, then distribution - they are less likely to pre-judge the programme based on a narrow set of short-term reference points.

Private markets are a long-term proposition. Those investors that stay allocated through the full cycle, resisting the urge to hit the pause button at or soon after the J-curve phase, are best placed to capture the illiquidity premium and develop a fully-fledged investment programme – one with funds at different stages of maturity, exhibiting both positive and negative cashflow, ultimately with self-sustaining characteristics. This outcome depends less on a single manager call than on the quality of the conversations that precede commitments, the governance structures that sustain them, and the information frameworks that allow stakeholders to evaluate private market allocations on their own terms.

When the mechanics, metrics and expected timelines are understood, private market exposures have a stronger chance of performing as intended - and governing bodies can make measured, well-founded decisions consistent with fiduciary duty.

David Scobie is a Principal at global investment firm Mercer, a Marsh business, based in Auckland.

This article does not contain investment advice relating to your particular circumstances. No investment decision should be made based on this information without first obtaining appropriate professional advice and considering your circumstances.