bfinance: Major shifts in private markets and asset allocation strategy
A new report from independent global investment consultancy, bfinance, has identified a key challenge in incorporating private market investments into strategic asset allocation models as private markets grow in institutional portfolios, due to a lack of robust benchmarks, particularly for returns and volatility. As liquidity dynamics evolve and market structures shift, the report suggests that investors must rethink private asset modelling and allocation strategies.
With private equity now representing 10% of public market capitalisation, asset owners must refine their approaches as they face challenges in the rapid growth in private market asset classes, decline in IPO activity, the long-standing downward trend in private equity fund distributions, and the ways in which GPs have pivoted towards other forms of exit.
The report found that liquidity risks remain a critical consideration, with nearly half of institutional investors (47%) expecting a reduced long-term illiquidity premium around 2-4%. The report suggests that private market investors should assume a 2% premium for buyout funds and a 3% premium for venture capital (geometric return). This shift challenges the assumption that private market investments will consistently outperform public markets and raises questions about appropriate risk-adjusted returns.
The report also highlights the diversification benefits of private markets. With IPO activity in decline and more companies opting for take-private transactions, the relationship between public and private markets is evolving. Although both markets respond to macroeconomic forces, a weakening correlation between private and public markets supports private market allocations as a diversification tool, particularly amid rising concentration in global public equities.
Further, the report raises concerns around return and volatility assumption, in particular, the limitations of internal rate of return (IRR) as a performance measure. Instead, time-weighted returns (TWR) can be a more reliable measure for asset allocation decisions. Volatility estimates must also be adjusted to reflect the true risk profile of private assets, as artificially smooth return patterns can lead to overstated diversification benefits.
Despite uncertainty, private markets remain a vital component of institutional portfolios. The report stresses the importance of strong governance and clear allocation frameworks to ensure investors can navigate the changing landscape effectively. Consistent investment strategies, GP-led secondaries, and semi-liquid structures are reshaping opportunities, while slower fundraising and high valuations may improve investor terms. Active oversight and disciplined decision-making will be key to long-term success.
Ruben Mutsaers, Senior Director, Portfolio Solutions at bfinance: 'Private markets are evolving fast, and investors must rethink allocation, risk, and governance. The days of assuming private equity will consistently deliver superior returns are over. There is a need for more robust modelling, realistic return expectations, and strong oversight to ensure private market investments remain a valuable component of institutional portfolios. By refining benchmarks and integrating a public-plus-premium approach, investors can make more informed decisions in an increasingly complex landscape.'
