Navigating liquidity challenges within private markets
Managing liquidity within a private markets program of closed end funds[1] can be a significant challenge for wealth managers, particularly for those venturing into the asset class for the first time.
From our experience, liquidity issues often stem from unpredictable fluctuations in distributions from the underlying investments. Successfully addressing these challenges requires careful planning and a strategic approach.
Liquidity challenge in private markets
To illustrate the complexities, let’s consider a wealth manager targeting a $100 million allocation to private markets. Typically, they might initiate this process by committing $30 million annually, gradually tapering this amount as they approach their target. Once the target allocation is reached, the objective is to maintain a stable commitment plan. However, this strategy hinges on the assumption that modelled distributions align with actual cashflows. In practice, distributions can slow down significantly, particularly during downturns in private asset sales, potentially leaving wealth managers overallocated to private markets.
Effective Liquidity Solutions for Wealth Managers
Given the unpredictability of private market distributions, several strategies have emerged to help wealth managers seek to manage liquidity. Here are some of the most commonly employed approaches.
This strategy, often referred to as a ‘do nothing’ strategy, involves accepting the volatility typically associated with the target private market allocation. Wealth managers recognize that during distribution slowdowns; they may be overweight in private markets. However, assuming most of their allocation is in traditional closed-end funds - their position may naturally come back down when distributions materialize. While this method allows for an average target exposure over time, it requires patience and a long-term perspective.
A popular strategy among wealth managers is the active adjustment of commitment pacing. If the portfolio becomes overweight in private markets, managers may reduce their target commitments. Conversely, if the portfolio is underweight, they may increase commitments to seek to accelerate exposure. Despite this feeling like a proactive adjustment to help stabilize the allocation, it can potentially result in greater volatility around the target allocation due to the time it typically take commitments to be drawdown.
The secondaries market has matured significantly, offering a viable option for seeking to manage liquidity. When faced with overallocation, wealth managers may sell existing holdings to aim to raise liquidity, albeit typically at a discount of 10-30% of Net Asset Value (NAV). While selling at a discount can be costly, it arguably provides an immediate solution for seeking to reduce exposure. Additionally, secondaries may be utilized with the aim of increasing exposure at attractive discounts, potentially enabling wealth managers to build up NAV and mitigate the J-curve effect typically associated with private market investments.
Co-investments have become a favored tool for rapidly building exposure when underweight. These investments often come at a reduced cost and provide direct access to deals alongside primary fund commitments. However, in our view, co-investments are primarily beneficial for increasing exposure and do not address the issue of overallocation.
Semi-liquid funds have emerged as a tool for managing liquidity in private markets. These funds typically offer quarterly liquidity, allowing for almost immediate investment rather than waiting years to build exposure. They provide several advantages:
- Portfolio Rebalancing: Closed-ended funds can in our view, complicate maintaining a target allocation due to unpredictable capital calls and distributions. Semi-liquid funds, however, tend to offer more predictable liquidity.
- Simplified Management: Semi-liquid funds may help streamline the management of a diversified private markets program, potentially reducing operational burdens and promoting overall management efficiency.
Key takeaways for wealth managers
- Selecting the right liquidity management approach involves considering various factors, including the client’s investment objectives, tolerance for illiquidity, and prevailing market conditions.
- It is essential to recognize that no single strategy will always be effective; market environments are dynamic
- A successful strategy in our view, combines multiple approaches. For example, maintaining a steady commitment plan while also utilising secondaries and semi-liquid funds may create a balanced and adaptable framework.
By understanding and implementing these strategies, wealth managers are placed to navigate the complexities of liquidity in private markets, ultimately enhancing their clients' investment experiences.
About the author(s)
Nick Rosenblatt
Global Wealth Manager Proposition Leader, Mercer
Mark Sheahan
is a Senior Alternatives Investment Director at Mercer, leading Alternative Investment programs across private markets in Europe. Previously, he managed a $6bn Global Fixed Income portfolio as a Portfolio Manager at AustralianSuper. He is a Fellow of the Institute of Chartered Accountants Ireland, Chartered Tax Advisor, and CFA® charterholder.
Michael Butler
Private Markets Investment Lead
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