The large asset owners survey from Mercer, published last week on Institutional Asset Manager, revealed that institutional investors are increasingly turning to private markets for their asset allocations.
However, the merging of public and private investments can create operational obstacles for investment firms behind the scenes, with asset management firms needing to adapt to support new requirements, regulations and investor demands.
To start with, David Nable, Managing Director at operational and data management tech provider to the investment industry, Arcesium, explains that the definition of private markets is a broad one.
“We think about private markets as investments made that are not happening and clearing on an exchange or are illiquid in that they can’t be transacted with at a trading desk through a broker,” Nable says.
This pulls in investments in infrastructure, from bridges to tunnels to roads, where the capital might go to the municipalities with payment coming from toll receipts, but also equity investing in private markets in the form of angel and venture investing to growth equity investing to take firms private in mega buyout deals.
Nable also notes that private credit is also growing, with examples of middle market or large cap firms giving private micro loans or transacting in these private loans in specialty finance business, such as buying up pools of Spanish car loans for example.
“You can buy all the loans, securitise them or just hold the loans,” he says. “The investment profile of underwriting the risk will look similar but the operational infrastructure looks dramatically different, but all of these things are in the private investment bucket.”
Nable has also observed the rise of peer to peer financing with loans of around USD5 to 10,000 in a direct to consumer model.
“This is a very different business from being the capital provider behind direct to consumer specialty finance and this has exploded on the back of social media,” he says.
Firms are getting their financing privately but have to be assessed before they can raise cash. “These are tech savvy lenders and it’s very different from going to a bank. The lending decision will be made on the number of impressions on social media, for instance. Private credit is growing in so many different ways, there is constant talk about new strategies, which the big firms are doing.”
Nable says that there are two ends of the spectrum – one the super institutional insurance companies that would have previously looked at government and high grade corporate bonds but are now looking at these private credit opportunities because they offer attractive yield and risk reward but the challenge for them is it requires specialised expertise in originating these transactions.
“There is a lot of partnership and merger and acquisition happening within private market investments in the insurance companies. The top 20 private market sponsors are all doing something in private credit partnership with insurance companies.”
Nable explains that his firm, Arcesium, has been a specialist technology company for the last 10 years, having spun out of D. E. Shaw Group to deliver their offering to other asset managers, providing operational and data infrastructure for asset managers to run complex business investments across the liquidity and illiquidity curve.
“Recent market volatility has been good for our clients who have navigated it quite well,” he says. “They are sophisticated clients who have robust risk management.”
Clients in this context are sophisticated hedge funds, pure play private market investors, banks, insurance companies, and sovereign wealth funds.
“Many different types of participants are trying to work out how to work with private credit and asset servicing clients are looking at how to manage the investments, while service clients are trying to work out how to underwrite direct lending or work with a private markets firm.
“We do see the asset owners, such as pension funds, interested in these activities. Some are very sophisticated, while others are allocating to managers and may be doing so via a separate account as opposed to a co-mingled fund.”
Separate account demand has been driven by the retailisation of this asset class, Nable says, but also applies to an asset owner such as an insurance or pension fund.
“A separate account brings a higher degree of customisation and control and it allows the manager and the investors to have a very specific risk return target,” Nable explains.
“It carries a tremendous amount of overhead but allows you to tailor the investment profile specifically to that investor’s objectives.”
And why are institutions, and even retail money, chasing private market investments? Nable says: “What we see is uncorrelated returns. The markets are illiquid and allow for more opportunity for risk adjusted outperformance and with the equity markets being so liquid for many players it is very difficult for the typical manager to outperform.”
Nable says that such a new market will bring new firms trying to sponsor products to meet demand, including the retail demand for private investments. “But you have to find a way that is compliant – how do you provide liquidity when the underlying assets are inherently illiquid? We are going to see lots of iterations on this.”
