Asset Allocation and Private Markets: A Guide to Investing with Private Equity, Private Debt and Private Real Assets. 2021. Cyril Demaria, Maurice Pedergnana, Remy He, Roger Rissi and Sarah Debrand. John Wiley & Sons.
Investment in the private market (PM), according to the authors of Asset allocation and private markets, brings some notable challenges. For example, performance analysis is problematic, due to stale prices arising from relatively illiquid trading.
The task is further complicated by the difficulty of calculating correlations between private and public asset returns. Fund managers can game internal rate of return (IRR) calculations by timing company sales or piling up debt to companies in order to pay large dividends. Moreover, volatility is a poor indicator of risk in PMs. Rebalancing is more difficult to implement than in public markets. Secondary markets for private assets are not reliable places to dispose of holdings; in 2008-2009, discounts to net asset value soared to 50% for leveraged buyout funds and more than 70% for venture capital funds. The rates are higher than those of public investments. Factor analysis is not applicable due to the low commercial activity.
Many endowments and foundations seeking to participate in private markets are disadvantaged by their lack of scale and limited expertise. Investors considering PM participation shouldn’t even think about market timing. Additional obstacles include informational asymmetries; less stringent disclosure requirements than in public markets, with audit not mandatory in some cases; and limited regulatory oversight.
The authors note some countervailing benefits of PM investment. They present data showing that private equity has historically outperformed public equity, on average, and argue that the advantage is not disappearing, despite increased capital flows into the asset class and reduced inefficiencies of the market In addition, private markets offer pure plays in certain industries to which investors can only gain public market exposure through large conglomerates. In addition, private markets allow for wider geographic diversification than their public counterparts.
As its title suggests, this book deals extensively with the critically important issue of asset allocation, viewed in the full context of the public and private market. Drawing on a combination of academic and professional experience, the authors establish a process for determining an investor’s risk horizon and appetite. Below are instructions for structuring multiple potential investment programs and characterizing each by its expected return and likelihood of achievement. The authors provide a particularly useful analysis of the challenges of benchmarking PM performance. This includes a detailed discussion of the relative merits of three metrics: IRR, multiple of invested capital, and public market equivalent. They also provide a practical approach to diversification within a PM category.
It is unthinkable that an institution that is considering taking the step to invest in the private market knows about Asset allocation and private markets and not study its contents diligently.
Even investors who trade exclusively in the public markets can benefit from the book’s thoughtful and sometimes unconventional reflections on a variety of topics. For example, the authors argue against the frequent claim that investors can do just as well by buying public securities on margin as they can by investing in leveraged buyout funds. They clear up the idea that the endowment model popularized by the late David Swensen is broken. Sustainability indices, they maintain, have a lower performance than conventional indices, with more risk. The authors even take issue with the concept of market capitalization, arguing that the value of a company is no equivalent to shares outstanding by price per share. Readers may not come away convinced in every case, but their thinking will have been sharpened on a number of essential investment topics.
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All posts are the opinion of the author. Therefore, they should not be construed as investment advice, nor do the views expressed necessarily reflect the views of the CFA Institute or the author’s employer.
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