Private-market assets not a panacea for returns

Business Times

04-05-2025

INTEREST in private-markets investing has never been greater. Mutual fund giants are partnering some of the best-known names in private assets, and are rolling out funds that retail investors can access.
But pointed questions are also being raised – more so at this time than before – on whether private-market assets can live up to the hype going forward. They are not a panacea for returns, and tend to underperform in a bull market.
The late David Swensen, who helmed Yale's endowment fund for over 30 years, pioneered outsized allocations into private assets. Yale's allocation into alternatives (alts) remains outsized, at more than 80 per cent. One-year returns up to June 2024 came to 5.7 per cent after fees. It has lagged against a strong showing by US stocks.
This is to be expected, said Yale's chief investment officer Matt Mendelsohn, 'particularly when exit markets for private assets are depressed'. Over longer periods of 10 and 20 years, Yale's endowment outperformed the median returns for US college and university endowments.
Many large institutions try to emulate Yale's portfolio, but most have failed to achieve the same results.
The latest data on US endowments, drawn from returns compiled by the National Association of College and University Business Officers (Nacubo), show a return of 6.8 per cent for end-2024 – just on par with the plain-vanilla balanced portfolio of 70 per cent stocks and 30 per cent bonds.
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A likely reason for underperformance is costs, as Richard Ennis, a pioneer of quant investing in the 1970s, argued in his recently published paper, 'The Demise of Alternative Investments'. He evaluated the performance of large US endowments using Nacubo data against a market index for 16 years to end-June 2024; in his analysis, large endowments returned 6.88 per cent, against a market index return of 9.27 per cent – an underperformance of 2.4 percentage points a year.
A portfolio of alts, he wrote, costs at least 3 to 4 per cent of asset value a year. An institutional portfolio's total expense ratio, depending on the size of the allocation, may come to 1 to 3 per cent.
In the private wealth market today, clients' allocation to private market assets is understood to be well below 10 per cent. Private banks are keen to push the needle up to 20 per cent. Meanwhile, the Monetary Authority of Singapore is seeking feedback on a framework to allow retail investors invest in private-market funds.
Are private-market assets the so-called holy grail of investing? For assets that involve more complexity, higher costs and less transparency, the way forward for retail investors isn't so clear-cut, even when evergreen or open-ended funds are made available. Unlike traditional private funds which are closed-ended and illiquid, evergreen funds have a liquidity window within limits, and are more palatable for individual investors.
New regime
Perhaps the most persuasive argument for an allocation into private markets is the view that a 'new regime' is currently underway where correlations between stock and bonds – previously negative – are now positive, and inflation is elevated. In its 2025 global outlook, BlackRock called for a re-evaluation of the traditional 60/40 portfolio (60 per cent equities, 40 per cent bonds) because of an 'ever-changing' outlook. Investors, it said, should take a dynamic approach and include private-market assets which enable participation in early-growth companies and non-bank financing.
Henry McVey, partner and head of global macro and asset allocation, KKR Global Institute, has published papers on what he calls a 'regime change', where fiscal spending is set to be higher, geopolitical risk intensifies, and inflation is stickier. In this environment, he argues for more 'control equity positions' and more active management of capital. Both can be harnessed via private equity (PE).
KKR found that PE has delivered excess annualised returns of 4.3 per cent over the past three decades. It also found that the outperformance was greatest in times when public equities faltered.
Of course, there are challenges. Pitchbook writes that the new tariffs, should they last, could have near- and long-term impacts on private markets.
It said that lack of economic clarity and persistent market volatility would cloud deal making and put pressure on exits. 'The (tariff) plan is generally regarded as more severe than expected, increasing the chances of a recession and retaliatory tariffs. This will add to deal making hesitation and keep pressure on an already stalled exit environment.'
Bain & Co, in its PE outlook report for 2025, expects the amount of dry powder at US$1.2 trillion and 'ageing' dry powder to exert additional pressure on deal making. Ageing dry powder – unspent capital held for four years or longer – has increased from 20 per cent of total dry powder to 24 per cent. Bain said that this 'suggests general partners are struggling to find first-rate, affordable targets'.
Manager selection is paramount
For individuals, yet another challenge is choosing the best manager. Unlike public securities, where market returns are easily captured via an index fund, the skills of individual fund managers are paramount in private markets. This is why new monies tend to gravitate to the largest funds with a proven track record.
Within private equity in particular, Alisa Wood, KKR partner and co-CEO of two open-ended PE funds, says broad industry returns data masks the huge dispersion or differential between the top- and bottom-performing managers, which is as much as 14 percentage points. 'Manager selection is key. The only way to make PE work is to invest in best-in-class managers, but it's really hard to get into the best managers.'
There is also a positive bias at play, she said. 'In terms of consistency of performance, the first-quartile performers tend to stay in first quartile because they typically have a proven playbook that they can execute time and again… You need to pick the best managers and then figure out how to get into those managers. That's the complicated part.'
High costs
In his paper, Ennis argued that high costs of a portfolio of alts have had a 'significantly adverse impact' on the performance of institutional investors since the global financial crisis of 2008. 'Alts bring extraordinary costs but ordinary returns – namely those of equity and fixed income assets,' he wrote. Hedge funds and real estate have been 'standout underperformers', he wrote.
The surge of monies into alts may have also resulted in more pedestrian returns, as competition intensified for the best deals. 'Private market investing is more competitive and efficient than it was way back when. Costs, though, remain high – far too high to support much value-added investing.'
But Ennis also castigated the 'agency problems and weak governance' in the supervision of institutional portfolios. 'Chief investment officers and consultant advisers who develop and implement investment strategy have an incentive to favour complex investment programmes. They also design the benchmarks used to evaluate performance.
'Compounding the incentive problem, trustees often pay bonuses based on performance relative to the benchmarks. This is an obvious governance failure.'
Advice gap
High costs and the agency problem are set to be minefields for retail investors, should access be allowed.
Funds of funds, a multi-manager and multi-strategy offering, offer convenient access as they address the challenge of manager and strategy selection. But they also charge a layer of fees on top of already-high underlying funds' fees.
The inherent conflicts of interest arising from more lucrative distribution fees warrant caution. It is an area, in addition to the quality of advice, that any framework to allow retail access should address.