Private markets have been one of the asset management industry’s big success stories over the past two decades. And while the ultra-low interest rate environment that fuelled much of the growth may be over, the incentives for generalist asset managers to diversify into or expand their presence in private markets are only getting stronger.
Once a cottage industry, private market assets under management have increased nearly 20% per annum since 2018 to reach $13.1 trillion as of 30 June 2023, observed McKinsey.[1] Boston Consulting Group predicts AUM growth for private equity, private debt and infrastructure will all be north of 10% from 2023-28.[2]
Private capital has become a mainstay of many investor portfolios. Institutional investors on the hunt for higher, more diversified returns and income streams have led the way. According to Preqin’s latest Institutional Allocation Study, institutions upped their alternatives exposures to a fifth of their portfolios in 2023.[3] Private equity dominates the allocations, especially among public pension funds, endowments and foundations, with private credit rising fast. LPs targeting income generation favour private debt, real estate and infrastructure, reported Preqin, noting real estate has the largest median allocation.[4]
While the higher interest rate environment may dampen performance, the rationale for investing in private markets remains. The returning cashflows and stable revenues of private capital assets, especially private debt and infrastructure debt, can act as a natural inflation hedge and offer stability against economic fluctuations. The recent tempering in corporate and real estate valuations will provide investment opportunities for current and future vintages. And with stock markets increasingly dominated by a handful of large caps (the Magnificent Seven accounted for 29.7% of the S&P 500 as of 17 April 2024[5] and drove 37% of the S&P 500’s 10.2% first-quarter gain[6]), and public markets shrinking as companies stay private for longer[7], investors have access to a broader opportunity set in the private sphere.
Green transition investment possibilities are reinforcing the trend. Private markets – a traditional facilitator of entrepreneurial innovation – will have an outsized role in the energy transition.
Alternatives driving global revenue for asset managers
Getting a slice of the private markets action will be ever more critical to generalist asset managers’ financial health. BCG’s Global Asset Management Report noted that investors are gravitating towards passively managed funds and other low fee products, hitting industry revenues, which increased a meagre 0.2% in 2023. Costs rose 4.3% during the year, and have climbed about 80% since 2010 at a compound annual growth rate of 5%. “Historically, the industry has been able to weather these pressures thanks to revenue growth that has been largely driven by market appreciation,” the report said. “In the years ahead, however, market appreciation is expected to slow, creating further challenges to the industry.”
To maintain the growth and profitability of past years, BCG advocates what it calls a three Ps approach, focused on increasing productivity, personalising customer engagement and expanding into private markets. The rationale is clear: alternatives generate more than half of global revenue, despite representing less than a quarter of total AUM, observed BCG. Private equity and private debt are expected to generate about 70% of total revenue from alternatives by 2028.
How to stand out
For generalist asset managers to develop a successful private market presence though takes expertise, dedication and investment. Differentiation will be key.
Stringent investment due diligence means front-office teams require a strong performance track record. To source the best investment opportunities, managers need a network of industry insiders and access to deal flow. To deliver returns, they must understand the portfolio companies and be able to implement needle-moving improvements.
Often-complex fund vehicles entail careful structuring. Efforts to attract retail wealth into private markets are particularly challenging. Hybrid funds offering private market access with partial liquidity windows are one increasingly popular approach.
Such funds may combine, say, 70% illiquid assets with 30% liquid ones in the same portfolio. Others are more aggressive, with a higher illiquidity ratio. Redemptions are not guaranteed, necessitating gating mechanisms to prevent runs and fire sales. In addition, portfolio monitoring and liquidity management are crucial in maximising returns while meeting investors’ liquidity expectations. Investor education, along with expert teams and sophisticated liquidity monitoring tools will be pivotal in striking the optimal balance.
Offering closed-ended or semi-closed-ended funds is no easier, demanding expert staff and systems to manage the capital calls and drawdowns, calculate complex fees and performance, perform the accounting, value assets, source and collate patchy data for ESG monitoring where appropriate, and report to investors and regulators.
Meeting the operational challenge
Working with a trusted third-party service provider can then help asset managers boost their operating set up to cope with the specificities of private capital funds.
Developing dedicated tools and teams internally to support a private capital business is expensive for generalist asset managers, and requires specific technological and operational expertise. Outsourcing the gamut of middle- and back-office tasks enables asset managers to get up and running quicker, at lower cost and with less risk.
Working with a proven partner allows firms to leverage the experience and infrastructure the outsourcing provider has in place, and profit from the efficiency gains it has achieved, and will achieve from its future investments. Knowing they have the support they need leaves managers free to focus on enhancing their portfolios and generating returns.
At BNP Paribas, our global middle- and back-office teams have long experience in servicing the entire spectrum of private market assets. We have expertise in all areas of the fund and investor lifecycle, from fund structuring and client onboarding to performance analysis, complex waterfall and fee calculations, asset valuations and regulatory compliance. Teams are abetted by an integrated suite of tools able to automate processes including portfolio and investor monitoring, liquidity management, fund accounting, NAV production and investor and regulatory reporting – a solution set we invest in constantly. A full range of financing options offer valuable flexibility where and when managers need it.
Through CapLink Private – our proprietary, web-based portal for GPs and LPs – we also help managers deliver the personalisation clients seek. CapLink Private manages workflows digitally, enabling online validation of notices and capital account statements before automated dissemination to investors. We also continually expand CapLink Private’s capabilities on top of existing features like benchmarking, risk analysis, forecasting and ESG scoring to align portfolio with responsible practices to better investment decisions. Our digital middle office solution revolutionises data accessibility, granting real-time access to pivotal information.
Embrace the future
Private markets offer generalist asset managers attractive growth possibilities at a time when their core businesses are coming under increasing strain. Delivering a standout private capital offering though takes exceptional front-office acumen supported by specialist operational skills. Outsourcing can take care of one part of the equation. The rest will demand long-term dedication and investment.
[1] McKinsey Global Private Markets Review 2024: Private markets in a slower era, McKinsey, 28 March 2024, https://www.mckinsey.com/industries/private-capital/our-insights/mckinseys-private-markets-annual-review
[2] Asset Management Report 2024, Boston Consulting Group, 6 May 2024, https://www.bcg.com/publications/2024/ai-next-wave-of-transformation
[3] Institutional Allocation Study 2024, 14 May 2024, Preqin, https://www.preqin.com/insights/research/reports/institutional-allocation-study-2024
[4] Strategy in Focus: Income Generation, Preqin, 3 May 2024, https://www.preqin.com/insights/research/reports/strategy-in-focus-income-generation
[5] Magnificent 7 Stocks Dominate The S&P 500 Even More Now, by Matt Krantz, Investor’s Business Daily, 19 April 2024, https://www.investors.com/etfs-and-funds/sectors/sp500-magnificent-7-stocks-dominate-even-more-now/
[6] The Magnificent 7 are no longer the only stocks driving S&P 500 to record highs, by Joseph Adinolfi, Morningstar, 31 March 2024, https://www.morningstar.com/news/marketwatch/20240331164/the-magnificent-7-are-no-longer-the-only-stocks-driving-sp-500-to-record-highs
[7] Between 1996 and 2023, the number of companies listed on the London Stock Exchange’s main market shrank by 60% and fell 40% in the US, Schroders Capital, 20 May 2024, https://citywire.com/wealth-manager/news/private-equity-myth-1-valuing-private-businesses/a2442734