A lack of robust benchmarks, particularly for returns and volatility, is a “key challenge” for investors seeking to incorporate private markets investments into strategic asset allocation models, according to new research from bfinance.
As liquidity dynamics evolve and market structures shift, the report suggests that investors “must rethink private asset modelling and allocation strategies”.
Bfinance’s report noted that 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 – Private markets and the asset allocation imperative – found that liquidity risks remain a critical consideration, with nearly half of institutional investors (47%) expecting a reduced long-term illiquidity premium of around 2% to 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, the report continued, 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 raised concerns around return and volatility assumption, in particular, the limitations of internal rate of return (IRR) as a performance measure. Instead, the research suggested, time-weighted returns (TWR) could 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,” the report said.
Despite the challenges and uncertainties identified, the bfinance report concluded that private markets remain a vital component of institutional portfolios. The report stressed the importance of strong governance and clear allocation frameworks to ensure investors can navigate the changing landscape effectively.
Ruben Mutsaers, senior director, portfolio solutions, at bfinance, said: “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.”
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