The last several years have seen true extremes in the private market environment, from very fluid and dynamic markets immediately after the COVID-19 pandemic to a period of relative inactivity amid higher interest rates, with fewer distributions and exit opportunities. Now, however, we are seeing signs of loosening that could help normalize the market. And with more liquidity, investors may need to think about how to deploy their assets to capitalize on current opportunities while fulfilling long-term goals. In this article, we provide some background on the current environment, and then go over some high-level considerations when it comes to potentially filling out exposures in the coming months.

A Deep Freeze

It’s worth noting how we got here. Coming out of the COVID lockdowns of 2020 and 2021, fiscal and monetary stimulus helped ensure easy access to cheap capital and strong markets. A healthy appetite for dealmaking and solid investment performance helped power private equity activity and fundraising to all-time highs. In 2022, the Federal Reserve’s rapid rate increases and broad public market weakness contributed to a significant drop-off in private markets activity, from fundraising to dealmaking to opportunities for investor “exits”—part of which was due to a wedge between sellers who were still looking for the best price and buyers mindful of not paying too much in a strained environment. Even as the rates and inflation picture improved, activity remained tepid into 2024 amid tough U.S. antitrust enforcement and uncertainty around global elections.

These trends fundamentally shifted the behavior of private equity general partners (GPs) in dealing with growing levels of “dry powder” available for investment. In our view, GPs exhibited sound discipline during this period, generally focusing new investments on high-quality businesses. Rather than push into questionable transactions, they looked to enhance their portfolio companies over longer-than-normal holding periods, and positioned them for eventual exit. When deals did occur, they were “add-ons” designed to fill out product, geographic or business gaps and to realize economies of scale.

For limited partners, subdued activity led to the lowest rate of distributions since the global financial crisis—and less than half the historical average.¹ As investors grew impatient with the lack of distributions, GPs started to get creative in ways to distribute capital while still holding on to what they considered promising companies. In some cases, they sought additional capital, which intensified demand for a range of capital and liquidity solutions—including private credit, capital solutions, secondaries and co-investments—that we have been talking about with clients for the last couple of years.

A Thawing Market

We believe the extended freeze on private market activity is beginning to thaw, with various forces aligning to release pent-up demand for deals. This includes buoyant public equity valuations, healthy economic growth, more stable inflation, a friendlier central bank outlook, the return of banks to the leveraged lending market, and a potential pullback in regulatory activism at the federal level.

Overall, we think this backdrop should translate into more transactions, increased distributions from existing investments, and more capital devoted to a range of private markets. As a result, investors may have more decisions to make regarding where to invest (or reinvest), how to fill out alternative investment exposures and how to structure portfolios overall.

Currently, we see pockets of opportunity in “core” traditional private equity funds as well as co-investments, where limited partners invest alongside private equity firms in a fee-advantaged arrangement, and real estate, which has suffered some weakness and now offers value to discerning investors. Also potentially appealing are select allocations to strategies focusing on liquidity/capital solutions, which, despite recent improved market conditions, can help investors work through a backlog of legacy investments and thus often provide appealing pricing. The latter group includes secondaries, which offer access to more mature companies/investments with an advantageous liquidity profile (of capital calls and distributions) compared to traditional vehicles, as well as structured equity solutions such as preferred equity. Private credit continues to benefit from banks’ movement away from underwriting areas like corporate credit, specialty finance and asset-backed lending.

Taking a Fresh Look at Allocations

Taking a step back, it’s crucial that any private market investments you choose fit within your broader portfolio, particularly as they relate to long-term goals and liquidity requirements.

Let’s assume that you are convinced about the case for private markets: their return potential and diversification advantages, the opportunity associated with the many privately owned companies now in existence, the practical leg-up that GPs have in building value in their holdings and their ability to be patient beyond the quarterly reporting dictates typically associated with public markets. What role can private market investments play in your broader portfolio, and how should you size and allocate them as you seek to maximize their benefit?

First, it’s helpful to think of these assets not in isolation, but in relation to their function in your portfolio. Traditional private equity segments may fit into the capital appreciation bucket of your portfolio along with public equities, while private credit strategies may, depending on their characteristics, represent a complement to traditional fixed income investments. Real assets, including real estate, infrastructure and commodities, can be an important diversifier and hedge to unanticipated inflation over time.

Hypothetical reallocations from traditional 60/40 portfolios (60% stocks/40% bonds) to include private markets exposure are shown below by investment objective. Depending on the mix, adding weightings in private markets has historically lessened portfolio volatility, reduced downside risk and led to greater growth potential (shown further down on the page).

Second, it’s important to regard the illiquidity of private markets as not just a limitation, but also a benefit. Yes, you often have to lock up capital for longer than public market assets, but the very length of a commitment allows for a strategic approach that has the potential to generate additional value. We’ve found that clients often overestimate their reliance on an investment portfolio to support near-term spending needs, freeing up assets where appropriate for more private market commitments in pursuit of better returns and diversification. The chart below highlights the positive impact on investment returns and risk management associated with a 20% allocation to various private market implementations, as outlined in the prior section.

With this in mind, how much may be appropriate when it comes to private markets exposure? To a significant extent, weightings may come down to the type of investor (individual, foundation, etc.) stage in life, goals and available assets for investing. Often, we see portfolio weightings correspond to the following types of clients:

• Lower Exposure (Up to 10%): A retiree whose portfolio is his sole source of income may have limited appetite for illiquidity, but can still benefit from the risk/reward and (in some cases) income profile of private markets. A business owner who already has much of her net worth tied up in illiquid company equity may value public markets diversification and, to a lesser extent, complementary private markets exposure. Meanwhile, a dedicated philanthropist who is focused on giving in the near term may wish to limit weightings in assets requiring a long holding period. This category often aligns with the “Income” portfolio shown above.
• Moderate Exposure (10 – 20%): A newly retired individual with a multidecade investment time horizon and moderate income needs may be a suitable candidate for moderate private markets exposure. A charitable foundation required to distribute 5% of its assets annually will likely need exposure to a more balanced asset allocation, but may be able to dedicate a meaningful portion of the rest of its portfolio to private markets. The same may apply to trusts making consistent distributions to beneficiaries. See the “Balanced” portfolio above.
• High Exposure (Over 20%): A long time horizon is a powerful investment weapon, and we believe those in their prime earning years should consider the merits of private markets where feasible, to capitalize on long timeframes for compounding potential. Another natural candidate for private markets could be a family with multigenerational wealth and/or low propensity to spend. Long-term trusts and institutions with perpetual time horizons and little need to spend from capital may be similarly situated. This category often ties in with the Growth mix, also above.

How much is appropriate for you should be a function of detailed discussions between you and your advisors in terms of what you are comfortable with and what you can practically commit. What may be particularly important is that your private market exposures be developed in a thoughtful, risk-managed way to maximize their potential to help your portfolio picture.

Developing Your Program

In our view, building a robust private market exposure involves diversification across multiple dimensions: asset class, strategy, industry, manager and vintage year. Depending on your objectives and risk tolerance, exposure may cross equity, credit and real assets (real estate and infrastructure), and employ an array of strategies with different cash-flow and risk profiles.

Given the degree to which portfolio manager performance can vary in private markets, we believe that access to top-tier managers is crucial, diversified across manager size, style, value creation approach and more. Fund-of-funds, co-investments and secondaries can be a source of efficient manager diversification.

Finally, diversification across time, or “vintage year,” should play a key consideration in developing your program. For those investing in traditional private market vehicles, their unique cash-flow patterns favor consistent investment commitments over time to ensure diversification based on vintage year, allowing capital to be deployed in a range of economic and market environments while maintaining target exposures prudently.

Next Steps

The public equity market has shown extraordinary strength over the past couple of years, with key indices becoming even more concentrated and valuations moving ever higher. In our view, investors would be wise to think about how to diversify into less traveled areas that may offer a compelling risk/return profile.

Private markets can provide a cornerstone of such diversification efforts. This is not an area that lends itself to market timing, nor to impromptu decision-making. Rather, we believe efforts to build an effective private market program should take place in systematic fashion across multiple years, and include regular maintenance to ensure that exposures remain on track. In our view, the potential “return to normal” of liquidity conditions should allow new opportunities to assess current strategies, and to explore new opportunities as they develop.