PIMFA
Accelerating capital deployment within a multi-sleeve private markets programme
For wealth managers venturing into private markets, it’s vital to realise that commitment doesn’t directly translate to exposure.
Typically, investors set an annual capital deployment goal to private markets. This is often grounded in an investment-pacing model. Throughout the year, they partner with various fund managers to hit this allocation. But after committing, limited partners (LPs) relinquish control over when and how much capital gets called — this is a discretion held by the general partner (GP). It is important to remember that during times of high economic uncertainty, GPs call capital less quickly. Notably, even three years post commitment, capital calls can vary considerably.
The operation of private markets is therefore unlike that of many asset classes that allow swift capital deployment post-allocation. Capital drawdowns fluctuate based on the fund manager’s sector and strategy. Sectors such as early-stage venture capital and biotech typically make minimal starting investments and earmark significant capital for subsequent financing rounds of their chosen companies (if they prosper). If ventures don’t pan out, this reserved capital redirects to other investments. Consequently, a manager might seem to be lagging in the pace of their investments since the reserved capital has not been called. The reality is that they could be leading, especially if they have a high “winner” count. This is a situation LPs can appreciate. Even within a single sector, variances exist.
For example, a buyout fund focused on add-on investments might reserve more capital than one emphasising operational enhancement. Predicting individual GP capital drawdowns remains challenging due to fluctuating market conditions and deal-closure success rates. However, given that most private market funds maintain compact portfolios (between 15 and 25 companies), a manager can swiftly shift from a lagging investment pace to a leading one if they seal more deals than anticipated.
In light of the above Mercer suggest that wealth managers take into account the following considerations:
- Strategic blueprint: Craft a resilient long-term portfolio strategy. Meeting risk and return goals while accommodating unique scenarios can help things sail smoothly, even during economic downturns.
- Employ a quality pacing plan: Due to the long-term nature of private markets, Mercer believe it is important to employ a quality cash-flow pacing model. This should allow for the testing of assumptions and for the determination of sensitivities. It will enable managers to anticipate liquidity needs and offset potential challenges, especially for newly established programmes.
- Vehicle consideration: Private market vehicles have evolved over the years, with some GPs now offering evergreen structures that can deploy capital immediately and reduce the J-curve effect. Additionally, interval fund structures have also seen considerable growth. These can reduce the complexities associated with pacing in closed-end fund structures.
- Liquidity lifeline: Bridge the gap between commitment and deployment by ensuring liquidity for unpredictable capital calls. Newer programmes may struggle more, whereas mature ones can balance calls with distributions. Stay agile during periods of high deal flows in order to manage liquidity adeptly. Consider allocations to secondaries and co-investments that offer benefits such as mitigation of the J-curve effect, reduction of “blind pool” risk, increased diversification and accelerated exposure buildup.
- Develop a robust manager selection process: Manager selection in private markets is critical. Elite managers recognise potential pitfalls and strategise to diminish their effects. For instance, many elite managers have deep experience across various market cycles and have developed toolsets that allow them to generate attractive returns even in poor markets.
- Balance discipline with adaptability: In tough times, seize the chance to partner with top-tier managers that have previously been out of reach. This could improve the lag between allocation and exposure while also improving the quality of the investor’s portfolio.
- Establish strong communication with managers: Engage proactively with private market managers. Although they aren’t bound by public disclosure norms, many are open to sharing insights, helping you gauge portfolio prospects more accurately.
Contact Sebastian Maciocia, Director of Wealth Management at Mercer, if you would like to discuss these issues further.
