Why this is a good time for investors to consider private markets.

As mentioned in my most recent letter, the Bank of England’s actions after the Brexit vote have exerted downward pressure on global yields. This has clearly benefited risk assets, but the persistent low-yield environment poses challenges for investors.

So how can investors deal with this dynamic? One option for long-term oriented investors to consider is allocating capital to private markets - i.e. unlisted assets. These investments include private equity, private debt, and private real estate - ranging from startup companies to distressed firms to buildings.

They require tolerance for significant illiquidity. First because they are unlisted. Second because fund managers require time and flexibility to add active value. In return, private markets can enhance portfolios thanks to their diversifying effect, as well as premium returns to compensate for the illiquidity.

Why private markets?

• Attractive returns in a low-yield, low-return world. Historically, private markets have generated premium returns compared to traditional assets over the long term. Pooled internal rates of return for US private equity over the last 20 years ending March 31 were 12.6%. The S&P 500’s time-weighted return for this period was 8.0%. Over the long term, we expect returns of 8–12% for private markets.
• Better risk-adjusted returns. Volatility and Sharpe ratios for private markets compare favorably to those of equities and bonds. 
• Additional sources of return for skilled investors. Investing in non-traded assets requires a different approach and skill set. There is no continuous market or pricing, information is limited, and buying assets takes time. These inefficiencies make the opportunity set compelling. Most investors simply don’t have the background or patience to realize the ultimate value of these assets. The resulting potential for mispricing is an opportunity. 
• Rapid growth in impact investing. Investors seeking both competitive financial returns and positive social or environmental impact, private markets are the primary channel to pursue this rapidly growing area.

What's the catch?

Successful investing in private markets requires expertise, tolerance for complexity, and a long-term mindset.

• Manager selection is critical. The gap between the top and bottom-performing fund managers is far wider than for equities or bonds. Investors must have access to top-quartile managers and a disciplined evaluation and selection process.
• Access is hard. It takes time and a strong network of relationships to build up diversified private market exposure. Funds are not always open and can be selective about their investors.
• Cash flow timing is unpredictable. Private market funds invest as opportunities arise, over multiple years. Equally, they return capital only after they exit underlying investments. That means investors must continually commit to new funds to maintain consistent portfolio exposure.