Some pension funds are managing the issue of needing to keep liquidity in portfolios while retaining private markets allocations. "We are seeing more attention to the pacing of investments — and understanding what investors are actually exposed to," Mr. Hobbs said. "Oftentimes you invest in these asset classes and your capital will be drawn over many quarters with the J-curve. Investors are now wanting to understand what that drawdown is going to look like … across their portfolio, and whether they're going to get spikes in demand for capital."
But a pension fund needing to sell out of private assets in order to move to a pension risk transfer and pass assets to an insurer — since illiquid assets will not, in general, be suitable for an insurer's asset pool — must exercise extra caution, sources said.
In these cases, executives might need to sell quickly in order to get to that buyout point as quickly as possible, before prices move. And it means taking a potentially huge haircut on the assets — maybe around 20%, sources said.
"For those situations, if the haircut is too big then selling in a hurry is counterintuitive," WTW's Mr. Ma warned. If the value of the sale is too low, the fund may actually be further away from the buyout point than thought, meaning they will then need to invest in more return-seeking assets and "build back up towards the premium," he said.
Thinking ahead and stress-testing the liquidity of the private markets allocations is now more important than ever. "You don't want to be selling private assets ahead of their natural maturity — in the majority of cases that will be expensive to do, complicated and time-consuming," said Elaine Torry, Glasgow, Scotland-based partner and co-head of DB investment at consultant Hymans Robertson LLP.
However, there are also potential opportunities for pension funds and other institutional investors with longer time horizons.
"There are other schemes, however, where that time horizon is still quite long," such as local government pension schemes in the U.K., which are still open to future accrual, said David Rae, London-based managing director and head of strategic client solutions at Russell Investments. "So actually, as much as there's a catalyst for some schemes to be looking to reduce private equity exposure," others are looking for attractive investments where they can pick up an illiquidity premium with good growth prospects, Mr. Rae said.
Whatever pension funds choose to do with their outsized private markets allocations, current events are serving as an "uncomfortable reminder that private markets are good but have three recurring challenges: the liquidity issue, that they're opaque and they're expensive. Times like these they all come home to bite," bfinance's Mr. Hobbs said. Until recent turmoil in public markets, those three challenges were able to be overlooked, "and the way investors have flocked to private markets and maybe not paid enough attention to the Achilles' heels of these asset classes" has also not been highlighted before.
They're also serving as a reminder to make those, potentially uncomfortable, asset allocation and haircut decisions now.
That's because, for some, it won't just be "a double whammy, but triple: You've got the rising cost of finance and rising debt; you've got investors being concerned about the asset class, being overweight and needing liquidity; and you've got the reduced income growth, rental growth and demand growth for the assets themselves," Mr. Hobbs warned. "It's a good time to think about different scenarios, take a view and maybe that 20% cut in the secondary market is worth taking rather than waiting until things are worse in six months' time."