Understanding private markets

While private markets offer opportunities for higher returns, investors must consider the associated risks and complexities.

For example, the effect of interest rates on private investments depends on the economic context, said Srikant Menon, director of alternative investments research with CIBC Asset Management.

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“The relationship between interest rates and private markets is not always straightforward,” Menon said.

Lower rates can boost valuations, as cheaper debt financing makes leveraged buyouts more attractive. But if a drop in interest rates is attributable to a weakening economy, any positive impact for private markets may be offset by broader economic concerns.

“Understanding these nuances is crucial for investors looking to navigate the complexities of private markets effectively,” Menon said.

He noted that some private funds, particularly those focused on real estate and private credit, have recently “encountered significant issues,” requiring halted redemptions, for instance.

“When a private fund faces difficulties, it often leads to a loss of investor confidence, prompting withdrawals that negatively impact the fund’s assets under management,” he said.

This, in turn, limits the fund’s ability to make new investments or support existing ones.

Also, “A common issue among struggling private credit firms is a lack of diversification, and concentration risk within their portfolios,” Menon said, which can impact performance. He highlighted a similar challenge with private real estate funds overexposed to assets such as office properties with high vacancy rates.

Evergreen funds holding such assets “are experiencing redemption requests that in some instances have reached up to 30% of assets under management, making it difficult to recycle capital without being forced to sell assets,” he said.

Menon advised investors to conduct “thorough” due diligence when selecting private funds.

“Understanding the fund’s strategy, the expertise of its management, and its risk management practices can help mitigate some of the risks associated with private fund investments,” he said. He also recommended diversification across funds and asset classes to buffer against potential troubles in any single investment.

Still, in an environment in which interest rates remain volatile, private credit offers the potential for attractive risk-adjusted returns, he said, and private equity also presents “compelling” opportunities.

“The ability to invest in companies at various stages of their growth cycle allows investors to capture substantial value creation,” he said.

He noted that demand for infrastructure investments has grown, driven by the need for upgrades and expansion in developed and emerging markets alike: “Infrastructure assets, such as energy, transportation and telecommunication are essential for economic development, and can provide reliable returns over extended periods.”

Real estate continues to be “a cornerstone of private markets,” he said, driven by demand for quality properties in prime locations. “Additionally, trends such as urbanization and the growth of e-commerce are creating new opportunities in sectors like logistics and data centres.”

Looking at sector innovation, Menon highlighted a surge in sustainable investments, and said these present new opportunities for forward-thinking investors.

He also noted that the push for renewable energy is driving investments in green infrastructure and clean technology. “Staying ahead of these trends can help one identify promising opportunities and make informed decisions,” he said. 

When comparing risk-adjusted returns between private credit and equity, he suggested considering the different risk profiles and return characteristics of each asset class.

Private credit typically offers more stable, predictable cash flows given regular interest payments, while private equity can offer higher potential returns but also greater risks.

“The value of equity investments in private businesses can be highly volatile, driven by factors such as market conditions, company performance and broader economic trends,” he said.

Investors seeking a balanced approach could allocate to both private credit and equity, which “allows them to benefit from the stability and income provided by private credit, while capturing the upside potential of equity investments.”

Menon also warned of illiquidity risk with private market investments. While evergreen products may have features such as redemption windows to help manage illiquidity, such feaures shouldn’t be viewed “as a tool for frequent asset reallocation or market timing,” he said. “Investors must understand that these features are not designed for active trading, and the misuse can lead to market distortions.”

Further, investors must “ensure that their risk tolerance and investment horizon aligns with the illiquid nature of these investments.”

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