Market Trends

Winds of Change in Private Markets

What are the trends and challenges that will influence growth and resilience for private market participants?

September 2021

Private markets experienced a distinctive and rather unexpected surge during the second half of 2020, with investors’ appetite for risk apparent in the clear rebound of private equity and private credit. We explore the new trends that have emerged in private markets during its growth over the past year and the challenges that market participants are looking to overcome in the next year.

Investors Turn to Private Markets for Returns and Diversification

At State Street, we have witnessed the growth of private markets as an opportunity for diversification.

From demand side growth, many investors are searching for alpha as they have seen that government bonds and listed securities may not deliver the long-term returns that are required against the liability mix. This has led investors to diversify their portfolios, particularly within private assets.

Private markets are now emerging as the front runner in investors’ quest for returns in a low yield environment, with assets likely to go up to US$12 trillion by 2025, translating to a growth of nearly 13 percent per year, according to Preqin1.

This growth is further fueled by the increasing accessibility of private markets to a wider spectrum of investors. What was once restricted to the largest institutional pension funds is now increasingly democratized to family offices, high net worth and individual investors. As more participants continue to enter this market, how will the mix of investor requirements be managed by general partners (GPs)?


The GP Challenges

In an environment of innovation, regulatory change and evolving client preferences, private markets managers have three main challenges to overcome that can facilitate better outcomes for their businesses and for their investors:

The data challenge: Private markets investors need consistent, asset-level data across the portfolio for better decision making, deal origination, valuations, portfolio monitoring and risk management. However, data is often siloed, residing in disparate systems, PDFs, Excel spreadsheets and multiple data sources, making a unified view difficult. In addition, most private markets investment data is stored in bespoke asset-level valuation models and fund managers have no ability to audit or forecast valuation changes without significant manual effort. With the growth in environmental, social and governance (ESG) priorities, ESG reporting and data challenges have also grown alongside. A State Street survey indicated that three out of four alternative managers said that reporting and analyzing ESG data is going to be one of their most important things to focus on in the next three years.

The operational challenge: Many aspects of front-, middle- and back-office functions continue to be performed manually, making it difficult for private market managers to quickly respond to major events in the market. For example, if the United States Federal Reserve cuts interest rates by 25 basis points, public markets can respond immediately, whereas private markets managers may take days or weeks to understand the impact of a rate cut on their portfolios and respond accordingly.

The technological challenge: Private markets managers are facing rising technology costs in different aspects of their business.

  • Multiple teams use disparate systems for various front-, middle- and back-office functions, which pushes up the cost for support and maintenance
  • As fund managers incorporate more private assets, they do not have systems with broad capability and functionality to deliver a whole portfolio view – a challenge that is largely mitigated by partnerships with outsourcing service providers
  • IT spends rise further from ever evolving regulatory and legal requirements – a single-platform solution with a provider that can provide services and tools for the front, middle and back office can help to keep technology spending to a minimum

Increasing Focus on ESG Priorities

With the hum around climate and social factors steadily increasing across the globe, ESG priorities are weighed from various perspectives: individuals, investors and regulators.

Institutional investors have an increased preference for ESG-committed funds for various reasons – be it to align with organizational values, minimize risk or to generate higher risk-adjusted returns in the long term. However, limited partners are equally focused on data governance of the ESG committed funds and are keen on going beyond Excel sheets and manual processes.

From a regulatory lens, global ESG regulations and laws have grown by 90 percent since 2016, according to a McKinsey2 report, where 2020 saw stringent efforts to standardize the frameworks and taxonomies. Consequently, to thrive in an ESG-focused landscape, powerful analytics and proactively integrating and reporting on ESG standards will be essential.

To clearly measure ESG factors within their portfolios, investors are taking a sharp look at their asset allocations. This shift in outlook has prompted new expectations in transparency. For instance, investors now expect asset managers to align their reporting to ESG standards, such as the United Nations’ Principles for Responsible Investment (UNPRI), so they can compare information from different managers and leverage it to make better business decisions.

Further, with regulations in the European Union prompting companies to participate in establishing a common set of ESG metrics and disclosure standards and similar efforts spearheaded by President Joe Biden’s administration in the United States, the regulatory environment is shifting with private equity firms and investors working towards quickly adapting to it.

For private markets participants, these trends and challenges have prompted the need to find the right partners to support them by enhancing their operational efficiency, bridging gaps with the right technology and providing actionable insights from diverse data – all of which can bring in cost savings and reduce the technology burden significantly.

 

1 Preqin Markets in Focus: Alternative Assets in the Americas

2A year of disruption in the private markets: McKinsey Global Private Markets Review 2021