Fifty years ago more people would have expected their future selves to have a flying car parked in their driveway than they would have envisioned private assets included in institutional investors' equity and fixed-income portfolios.
"It's probably fair to say that alternatives are just as common as traditional investments" in institutional investors' portfolios now, said John Delaney, senior director of portfolio management at Willis Towers Watson.
Private market asset classes are no longer alternatives to most asset owners, but building blocks used to construct their investment strategies, Delaney said.
For most investors, it's been an evolution, with investors' real estate investments, for example, becoming a broader real assets strategy, he said. High-yield debt and loans evolved into private credit, Delaney added.
"The combination of traditional and alternative exposures has become the norm of what we see today," he said.
Indeed, the private capital money management industry is growing at a fast clip, without any signs that it will slow down anytime soon.
Between 2017 and 2022, private market firms' combined assets under management grew at an annual rate of close to 20%, McKinsey & Co. reported. Private capital total assets AUM is expected to double to $23.3 trillion by the end of 2027 from $11.7 trillion as of June 30, 2022, a Preqin analysis shows. That's up from roughly $5 trillion in 2017.
Over the next half century, private market executives expect that investments in the asset classes will have a far-reaching impact on the economy and on society.
"Global proliferation of the asset class and adoption by retail investors will grow private markets to $150 trillion" in 50 years, said Jeff Diehl, managing partner and head of investments at alternative investments firm Adams Street Partners.
Diehl said he also expects to see more substantial partnerships between governments, private markets money managers and private companies that will drive economic growth by creating jobs and stimulating investment.
"I also believe that the innovation unleashed by private markets will cure cancer and paralysis, make space travel ubiquitous, nearly complete the transition to solar power and successfully meld human brains with machine intelligence," Diehl said.
Some industry insiders wouldn't go quite that far.
Private market asset classes are "certainly essential for institutional investors that want to seek out the best risk-adjusted returns given how much of the opportunity set has shifted to private markets," said Armen Panossian, head of performing credit and incoming co-CEO of Oaktree Capital Management.
"Importantly, private markets enable capital to be provided by long-term oriented investors to endeavors that may not be well suited to public markets while also, in many cases, increasing systemic resilience by providing continued access to credit and capital, the lifeblood of the economy, during times of disruption when other financing channels may not be available," Panossian added.
North America private capital is expected to produce an 11.8% internal rate of return each year through 2027, according to Preqin. Venture capital is expected to offer the best performance during the period with an annual 13.8% from 2021 to 2027. Private equity is anticipated to return 13.5% over the same period, which is 2.7 percentage points below its annual average 16.2% IRR from 2015 to 2021, Preqin reported.
Supporting businesses that could benefit society is easier to do in the private markets, said Willis Towers Watson's Delaney.
In 2022, the U.S. private equity sector alone included approximately 5,000 private equity firms and 18,000 PE-backed companies, according to a report for the American Investment Council, a private equity money management industry trade group.
Many of the companies involved in artificial intelligence or medical advances are private companies and a big portion of those are backed by private equity, venture capital and/or private debt managers, Delaney said.
Healthcare is already a big theme across private capital asset classes. Since 2012, private equity firms have backed 966 U.S. life sciences companies and 924 medical devices and supplies companies, investing about $280 billion, according to a March 2022 American Investment Council report.
"The private investment space is ripe for making improvements in society," as well as generating returns, he said.
The private market is also at the forefront of innovations in technology and life sciences among other areas, industry professionals say.
"As we all experienced firsthand during the pandemic, software has fundamentally changed the way the world does business," accelerating a digital transformation at companies of all types and sizes, said Michael Fosnaugh, senior managing director, co-head of flagship fund at private equity firm Vista Equity Partners. "Many of these advances were fueled by capital and operational expertise provided by the private markets."
He does not see that dynamic changing anytime soon.
"According to our own data, approximately 97% of enterprise software companies — and therefore investment opportunities — are in private markets," he said.
What's more, the sectors available in the private markets are expanding.
A decade ago, private credit "was a fledgling industry and institutions were still trying to determine whether and when to allocate to it," said Ken Kencel, president and CEO of Churchill Asset Management.
"Today, as the private credit industry nears $1.5 trillion in AUM, investors are increasingly turning to the asset class as a less correlated portfolio diversifier with attractive risk-adjusted returns and stable income through various market environments."
Today, private credit managers are taking over the business of banks.
"Direct lending LBOs (leveraged buyouts) are already outpacing syndicated (bank-backed) LBOs by 11.5 times, so I think it's safe to say private credit managers will start to look like the banks of the past," Kencel said.
Investors have also been drawn to private markets to boost the returns of their portfolios in a lower and lower return environment, industry insiders say.
"Allocating to private market investments such as private credit and private equity can provide meaningful exposure to strategies that have typically outperformed over the long run," said James Clarke, global head of institutional business development at Blue Owl Capital.
But the private markets industry needs to keep evolving to continue being an important element of institutional investors' portfolios, some managers say.
"The industry needs to continuously innovate and uncover assets that deliver on the original 'promise of alternative investing,'" by investing in non-correlated assets before the rest of the institutional world has discovered them, said Chris Heller, co-founder and co-managing partner at Cordillera Investment Partners, a $1.5 billion alternative investment firm focused on investing in niche assets.
These tenets formed the basis of alternative investments' promise in the late 1970s and early 1980s "and have been somewhat lost today," Heller said.
"In the long game of private markets, the differentiating factor between the winners and losers will place the investors who were early to identify the 'next big thing' right on top," he added.
The expansion of private market asset classes is not without growing pains.
About 1.3 million retail industry jobs at companies owned by private equity firms were lost over the 10 year through 2019 — made up of 597,000 at the portfolio companies and 728,000 jobs lost at suppliers and local businesses — according to a 2019 report by six advocacy groups including the Private Equity Stakeholder Project, Center for Popular Democracy and United for Respect. Overall, employment shrinks 13% on average over two years after buyouts of publicly listed firms, but expands 13% after buyouts of privately held firms, a paper studying buyouts from 1980 to 2013 by six researchers including Josh Lerner, the Jacob H. Schiff professor of investment banking at Harvard Business School, and Javier Miranda, a professor at the Friedrich Schiller University Jena.
However, an Ernst & Young report for the American Investment Council released in April said that net employment was approximately unchanged two years after a leveraged buyout. EY studied private equity-backed companies two years after a leveraged buyout between 1980 and 2005.
Asset owners are taking notice. A number of investors, including the $316.7 billion California State Teachers' Retirement System, West Sacramento, and the $143 billion State of Wisconsin Investment Board, Madison, are including human capital management as an investment consideration.
The $457.9 billion California Public Employees' Retirement System, Sacramento, is extending those considerations to its private market portfolio. At its Nov. 13 investment committee meeting, CalPERS is expected to decide whether to adopt a labor practices policy aiming to encourage money managers, starting with private equity general partners, to seek to eliminate egregious labor practices including employing child labor, undermining workers' collective bargaining rights and failing to provide safe and healthy workplaces.
Over the past 50 years, the private markets "industry could have done a better job about educating the broader public about the value it brings to companies it invests in and their stakeholders at an earlier stage to avoid some of the 'Barbarians at the Gate' image that still some associate the industry with," Oaktree's Panossian said in answer to a question about what the industry could have done differently.
"We need (in the next 50 years) to continue being good stewards of capital for our investors, good partners to the companies we invest in, and good members of the communities we operate in," Panossian said.
