As investors pile ever more capital into alternative investments, including private equity, some in the industry are beginning to wonder about the wisdom of holding illiquid investments if stocks crash.
Preqin expects alternative investment assets under management to reach $14 trillion by 2023.
From 2009 to 2018, more than $3 trillion has flowed into private equity and venture capital funds worldwide, according to a recent PitchBook study. Private equity funds raised $2.6 trillion of the total.
"The massive amounts of capital flowing in and out of the private markets was my 'stand back, `wow' moment," said Adley Bowden, Seattle-based vice president of research and analysis at PitchBook and author of the study.
Private equity raised $500 billion in 2018, he noted.
"It seems like huge sums but it has steadily built up ... in the past decade," Mr. Bowden said.
And investors are not showing any signs of slowing down. Some 66% indicated they expect to increase their alternative investment allocations over the next five years, outstripping interest in increasing allocation targets to any other asset class, according to a PitchBook survey.
The question is whether private equity and venture capital has enough capacity for this capital, Mr. Bowden said. "How many companies that are worth funding … is a question that the industry is grappling with," he said.
Industry executives are concerned with concentration risk. But investors take comfort in the fact that they were able to weather the global financial crisis. And the average institutional investor still only has a small slice invested in alternative investments, he said. The median allocation to private markets from North American public pension plans is 6.7%; in Europe it's 3.9%.
"It's rare that liquidity needs force investors to sell PE positions," said Antoine Drean, founder, chairman and CEO of Triago, a private equity fund advisory firm. "In stock market crashes, investors have sold private equity positions, or more frequently frozen their investment programs, as falling stock prices inflated more resilient private equity positions well above allocation targets."
Generally, when faced with liquidity pressure, most investors will choose to sell stocks because they are more liquid.
"Almost all institutional investors have diversified portfolios that allow them to choose what assets to sell in case they need to generate liquidity," Mr. Drean said. "For all of the above reasons, in public market routs, investors will choose to sell stocks over harder-to-sell and arguably much more resilient private equity."
Ludovic Phalippou, professor of financial economics at Saïd Business School, University of Oxford, acknowledged that investors need to pay attention to liquidity risk.
However, the secondary markets are a lot more developed than they were in 2008, he said. "Most investors should be able to navigate through a liquidity crisis by selling assets other than their private equity ones, and using the secondary market at the margin."
However, investors that do sell on the secondary markets, especially when they need the liquidity, will be hurt because of the significant discount, noted Sasha Grutman, New York-based co-founding partner of Middlemarch Partners LLC, a merchant bank with investment banking and private equity investment management units.
"When you try to sell out in the middle (of a fund's life), it will generally be discounted pretty heavily" to account for selling the investment prematurely, Mr. Grutman said. "For somebody with liquidity needs, private markets are strange bedfellows."
