November 6, 2023


Private markets offer multiple potential benefits — with relative outperformance at the top of the list — and appear to show no signs of slowing down

Private Markets Webinar

This webinar highlights the tailwinds – and challenges – across private equity, private credit and specialty finance, providing insight into market segments and sectors that leading managers are focused on. How should investors in private markets be positioned as they navigate the wider macro and economic environment? A closer evaluation of investment strategy, deal terms, valuations and benchmarking are at the forefront, with this expert panel sharing practical and timely perspective across the private markets.
Jad Stella
Senior Director, Private Investments
Cambridge Associates
Jeremy Knox
Senior Investment Director
Schroders Capital
Avi Tolani, CFA
Senior Vice President, Enhanced Middle Market Credit
Voya Investment Management
Wednesday, November 8, 2023
2:00 p.m. ET

Institutional investors are big fans of private markets. And rightfully so: Private markets have offered not only traditional advantages such as historically high relative returns and sound diversification, but also more recent ones such as bespoke structuring to meet specific portfolio objectives and access to potential alpha opportunities from new technologies.

The high relative returns speak for themselves — loudly — according to Jad Stella, senior director, private investments and special projects at Cambridge Associates. The firm collaborates with S&P Dow Jones Indices on private markets benchmarks that are available to the industry. “Outperformance is one of the biggest reasons why investors look to private markets. Our research has shown that private investments can play an important role in an investor’s portfolio. Some of the best-performing institutional portfolios maintain large allocations to private investments,” he said.

To underscore his point, Stella cited Cambridge’s private equity index, which outperformed the MSCI All Country World index, its modified public market equivalent, by an average of 640 basis points over the most recent five-, 10-, 15-, 20- and 25-year periods.1 The average outperformance for its private credit index (versus the modified Bloomberg US Government/Credit Bond index) over the same periods was 693 bps. For its venture capital index, the corresponding number was 662 bps versus the modified Russell 3000 index.

Private markets additionally have seen wide dispersion of returns, suggesting there are opportunities to potentially generate gains. Over the past 15 years,2 the difference between the median and fifth percentile returns for the Cambridge private equity and venture capital indexes was 23.7 and 30.9 percentage points respectively, Stella noted.

1 As of March 31, 2023.
2 From January 1, 2008 through December 31, 2022.

Multifaceted diversification

While performance is the ultimate objective for any investment, diversification looms large as well. There are a number of ways in which private markets can help to diversify institutional portfolios.

Avi Tolani, CFA, senior vice president and co-team lead for enhanced middle-market credit at Voya Investment Management, highlighted how private markets offer a faster-growing investment universe than public markets. “The sheer increase in privately owned businesses means that investors can find many more opportunities and be much more selective as they do so,” he said.

Diversification via private markets can help to manage overall portfolio volatility, Tolani added. “There’s a lower degree of correlation between private markets and the traditional asset classes that institutions invest in,” he said. “Owning assets like private credit, private equity and project finance, or infrastructure, can help cushion institutional portfolios when markets are volatile.”

Cambridge’s Stella singled out private credit for its potential to offset volatility in public debt markets. “Certain private credit strategies can help investors by providing an alternative to traditional fixed income. These strategies tend to have a lower risk-return profile compared with private equity or venture capital and have the potential to provide a more predictable return stream,” he said.

Read: Benchmarking private investment performance

Macro supports…

In addition to robust historical returns and an attractive diversification profile, private markets benefit from strong macro tailwinds.

According to Jeremy Knox, senior investment director at Schroders Capital, these tailwinds aren’t necessarily the usual suspects from the past few years. He noted that many of the forces that kept private markets buoyant — notably low interest rates, plentiful credit and rising valuations — either have abated or simply don’t exist anymore. That has shifted investors’ focus to other underlying drivers.

“Technological innovation is an important driver as investors seek out companies creating new technologies or using existing technologies in a creative way,” said Knox. “The investable universe for private markets is also much, much larger versus public markets, and it continues to increase as companies stay private longer. Finally, we believe that many large asset owners, such as insurance companies or pension plans, are under-allocated to private markets and will aim to raise their allocations.”

Gaurav Ahuja, CFA, senior vice president and co-team lead for enhanced middle-market credit at Voya, expanded on how higher interest rates can benefit private markets. “Earlier this year, higher rates directly contributed to the collapse of three regional U.S. banks, the forced sale of Credit Suisse and the overall retrenchment in bank lending,” he said. “This has given private lenders an unexpected opportunity as borrowers have fewer options for funding. We expect yields to remain at elevated levels in the near to medium term, meaning that this window for private lenders should be open for a while.”

An upcoming avalanche of lower-cost corporate debt maturities also bodes well for private credit. About $160 billion of the loan market will mature in 2024 and 2025, and borrowers will need to refinance much of it, Ahuja explained. This should benefit private lenders in two ways. Assuming banks will continue retrenching from the market, they would remain hesitant to refinance or extend loans, and private lenders would benefit by being able to negotiate conservative structures and thoughtfully curated covenants.. Second, if rates stay “higher for longer”, refinancing at higher rates and spreads would help create an attractive vintage for investors.

…and challenges, too

The environment for private markets presents macro headwinds as well, and Schroders’ Knox cited several significant ones.

The first is the widely held market view that interest rates will remain at elevated levels longer than expected, which would keep capital costs high and dampen prospective returns for private equity portfolios. Next is the impact of a potential slowdown in consumer spending and capital expenditures. Such a slowdown could reduce top-line revenue as well as free cash flows for both venture-backed companies and private equity buyout investments.

Knox also highlighted geopolitical risks — Ukraine and oil prices, for example — that could prompt wide swings in investor behavior. Finally, he cited technology risks best exemplified by artificial intelligence, which could rapidly change the outlook for broad swaths of the economy.

Furthermore, some pension plans are scaling back their allocations to private markets due to several factors. These include the greater attractiveness of traditional fixed income since interest rates have risen and the need for more liquidity than private markets typically provide.

Private Markets Outperformance vs. Public Markets*
*Average outperformance for the most recent 5-, 10-, 15-, 20- and 25-year periods for Cambridge Associates’ private markets indexes. All financial investments involve risk. Depending on the type of investment, losses can be unlimited. Past performance is not indicative of future returns.
Source: Cambridge Associates


Asset managers are optimistic about private markets performance, notably by seasoned managers who can navigate the complexities of the asset class

Assuming that the underlying drivers will remain in place in the near to medium term, the outlook for private markets is positive. Navigating through the macro effects across the economy and the complexities of the asset class, however, requires a closer consideration of manager selection.

As Voya’s Tolani put it, “We feel bullish and excited about the opportunity set ahead in the U.S. and globally, particularly in the middle-market credit space. Private investors should see more opportunities created by the ongoing disintermediation from public to private markets, the challenges confronting banks and the refinancing wave coming up in 2024 and 2025.”

Schroders’ Knox is bullish as well on the private equity space. “We expect strong activity and performance to continue in our focus area of small and mid-size buyouts, driven in part by the supply-demand imbalance between available capital and the size of the target-company universe,” he said.

“We focus on buying companies for lower purchase multiples and with lower leverage, as we’ve done for many years. We do this around the globe as co-investors with best-in-class private equity general partners. Relative to the opportunity set, prospects are particularly good for investors that can co-underwrite opportunities with their GPs, which benefits transactions by providing value-added capital and certainty of execution. We are well positioned that way and believe it is a differentiating factor for us in today’s market,” said Knox.

Opportunities come knocking

Where can investors currently find opportunities in private markets?

Voya’s Ahuja sees a number of promising areas within private credit. One is complex transactions related to rescue financing, where he expects more activity due to underperformance in the underlying credits, defaults or companies going into or coming out of bankruptcy. Other sectors of interest are energy, infrastructure and other areas of project finance.

Voya is finding opportunities in developed and emerging nations whose credit markets have tightened more than the U.S., Ahuja added. “We’ve been seeing many more opportunities outside the U.S. in the last 12 months. Non-U.S. markets have noticed private credit’s success here, and some of them are catching up. There are more opportunities in Europe, and activity is picking up in Australia, New Zealand and Asia.”

In private equity, Schroders’ Knox favors small- and middle-market buyouts, early-stage venture capital and growth investments in high-growth and demographically compelling countries such as India. Because Schroders’ strategy focuses on sectors that are resilient and robust, it gravitates toward industries providing non-discretionary products or services with stable demand. These include healthcare, business services, technology and consumer staples.

Small Buyouts Have Lower Multiples Than Large Buyouts
Source: Schroders Capital, 2023, based on data on North American and European market from Capital IQ and the Baird Global M&A report. Data as of December 31, 2022. Past performance is not a guide to future performance.

Manager selection is critical

Yet even as asset owners explore private markets opportunities, these sectors can be difficult to navigate because of their singular combination of complexity and opacity. For institutions, selecting the right manager is critically important to performance.

“Just because someone decides to invest in private investments, it doesn’t mean that they’re automatically going to have good performance,” said Cambridge Associates’ Stella. “Manager selection — both for access to investments and strategy implementation — is vital to the success of a private markets allocation. Institutions must not only choose high-quality fund managers, they also need to commit appropriate amounts of capital to funds across vintages and strategies.”

What does a good manager look like? Schroders’ Knox believes it’s all about strategy, track record and team — and consistency across all of them. Managers should maintain discipline in their strategy and execution, he said. Performance must be consistent on an absolute and relative basis over the long term for investors to have confidence in a manager’s ability to invest across economic cycles. Team stability is also a major factor.

Voya’s Tolani emphasized several other characteristics that investors should expect from their private credit managers. “In stressful environments like today’s, it’s important that fund managers have the mandate to be flexible across different parts of the cap structure, geographies, sectors and even asset classes that are adjacent to their target market,” he said. “The same goes for the ability and expertise to manage distressed situations like workouts or restructurings.”

Managers should have extensive sourcing networks that enable them to find unique and diversifying transactions, Tolani added. They also should have the ability to underwrite more complex deals, which would allow them to capture complexity premia.

Tolani’s final point was specifically aimed at institutions looking to initiate exposure to private credit. “These investors need managers who have navigated through multiple credit cycles, whether it was the great financial crisis, the oil crisis, COVID or 2022’s extreme volatility,” he said. “We’re going through a period of volatility right now that potentially could worsen, which makes the selection of seasoned managers especially important.”

Read: Private Investment Benchmarks by Cambridge Associates



Private equity and private credit are the biggest categories within this space

While private equity gets most of the headlines, private credit is fast becoming a must-have asset class for institutions as well.

Cambridge Associates categorizes private credit into two main buckets, Stella said. The first is return-maximizing strategies, which focus on capital appreciation and typically target returns in the high teens. Credit opportunities and distressed corporate credit funds account for the lion’s share of these types of strategies.

The second private credit bucket is capital preservation strategies, which aim to generate predictable returns and reduce downside risk, he said. Target returns are in the high single digits to low teens for these types of funds, which include senior debt and subordinated capital strategies.

Cambridge also tracks niche specialty finance strategies, Stella noted. These can run across the spectrum of risk-return profiles and have an idiosyncratic component to their approaches. Some specialty finance funds might aim to maximize returns, for instance, while others might focus on preserving capital. Examples of these strategies include aircraft leasing and healthcare royalties.

Voya’s Ahuja believes there will be an evolution of the competitive landscape between public and private markets. “As more investors come into the private market, we expect the illiquidity premium to compress,” he said. “When that happens, there will be more of a pendulum between the private and public sides, where borrowers will explore both markets. However, we expect that private markets will continue to benefit from secular trends that have been in place since well before the recent banking crisis.”

Investor-friendly structuring

In the past couple of years, according to Voya’s Tolani, the environment for private credit structuring has shifted from one favoring borrowers to one in which deal terms are more advantageous to lenders.

“We’re seeing better yields and, obviously, higher base rates,” he said. “Along with that, credit underwriting standards have tightened from when there was a lot of flexibility afforded to borrowers to the detriment of investors.”

Tolani also sees a decline in borrower leverage, which strengthens credit quality. “There’s more equity coming in as a percentage of total capital than in the past. Structures and yields are favoring lenders so much that we believe the next 24 months are going to be a great period for investing in private credit,” he said.

Borrowers could benefit from the current structural environment via deal terms that align their interests with those of lenders, Tolani added. Lenders can structure deals creatively so that borrowers pay out less cash, for instance.

Cycle agnostic

How does Voya invest in private credit? Ahuja summarized the firm’s approach.

“Our strategy focuses on three key markets: middle-market lending, below-investment-grade private placements and project finance,” he said. “That’s a pretty wide box compared to some of the more narrowly focused private credit managers. We pivot among these three verticals across different geographies and pick the best risk-adjusted opportunities we find in each. We’re looking for a favorable structure and an attractive yield premium. The flexibility to pivot among the verticals is vital, as these markets offer not only uncorrelated returns, but also uncorrelated deal flow, which is especially important in a period of lower deal activity like the present.”

Voya’s underwriting philosophy emphasizes capital preservation, particularly when managing for pension plans and insurance companies, Ahuja said. Rather than allocate its portfolios on a sectoral basis, it focuses on finding individual borrowers that are cycle agnostic: Companies should be able to survive and thrive through a recession or a tough cycle both in the economy and the capital markets. They should be able to pass through cost increases and inflationary pressures to their customers as well.

Haves and have-nots

In private equity, Schroders’ Knox describes the current marketplace as consisting of haves and have-nots. Valuations reflect this dichotomy, he observed.

“Valuations have been stable for healthy companies that have shown resiliency and robustness through the last couple of years and have strong growth tailwinds going forward,” said Knox. “We really have not seen much of a contraction in multiples paid for these companies. They continue to trade for what we think are healthy multiples that indicate the strength of the companies and their business models.”

On the hand, he said, investors have been less receptive to companies that may have some form of complexity around their story or volatility in terms of their earnings stream or normalization of earnings post-pandemic. Some of these companies have seen lower valuations — or haven’t even garnered bids to begin with. Schroders is watching this situation closely, as it materially affects overall deal volume and activity.

Knox reiterated his confidence in the middle market for buyouts. He noted that there is an abundance of potential investment targets and a tremendous opportunity to help professionalize what, in many cases, were family- or founder-owned and operated companies. This dynamic shifts the focus of value-creation plans to operational improvements and growth rather than returns through financial engineering, as leverage plays a much smaller role in the middle market than in the larger market.

What’s more, Knox is especially upbeat about co-investment in middle-market buyouts, calling them “a huge opportunity set in the medium and long term.” Tighter credit availability, he added, is driving sponsors to work more closely with seasoned and experienced co-investors that can help to close deals and facilitate ongoing activity. As a result, “the market backdrop is really playing into the hands of well-capitalized co-investment partners that can move quickly and efficiently. We think this is a golden age for well-capitalized, professional co-investors like us, and we are trying to take advantage of that.”

Sticking to its knitting

Schroders has followed its disciplined and consistent investment approach over the years, regardless of macroeconomic and marketplace conditions, and Knox sees no reason for that to change.

“We really have not altered our strategy much. We continue to deploy into the areas that we find attractive, which tend to be less dependent on the capital markets,” he said. “This means small- and mid-cap buyouts that are driven by operational value creation at the portfolio-company level as well as early-stage venture capital, where there is less capital markets involvement and less late-stage, momentum-type investing.”

It’s fair to say that Schroders takes an all-weather approach to private equity. “If you look back at our deployment activity and performance across vintage years, we have historically had very strong returns during periods of recession and boom times alike,” said Knox. “It is absolutely paramount to how we position ourselves and create portfolios for our clients.”

Yields for Direct Middle-Market Loans vs. Large Corporate Loans
Data as of June 30, 2023.
Source: Refinitiv LPC; Voya Investment Management.


A lot of thinking goes into how to construct effective benchmarks for private markets

It’s one thing to invest in private markets — and quite another to accurately measure how well an investment performs. An effective benchmark should provide insight into investor questions such as: Is it worthwhile to invest in private versus public markets? Was our decision to allocate capital to private markets a good one? Have we selected strong private fund managers? How well have we allocated across broad and narrower strategies, sectors, geographies and vintages?

“As private investments have grown over the years, we’ve seen significant demand for data as investors look to understand how their private investments have performed,” said Cambridge Associates’ Stella.

At Cambridge, “We use our robust data set to benchmark our own portfolios when we’re underwriting prospective new managers and opportunities, and we make the data available to our clients and the fund managers that share their performance data with us. The data comes directly from fund managers’ quarterly and annual audited fund financial statements. We make sure it’s consistently sourced and presented across all different strategies: venture capital, private equity, real assets, private credit, etc.,” Stella said.

He also highlighted two concepts as being critical to effective benchmarking. The first is the use of modified public-market-equivalent indexes, or MPMEs, which simulate performance of private investments cash flows in public markets such as the S&P 500. MPMEs enable investors to make apples-to-apples comparisons when evaluating private performance.

The second critical concept is Cambridge’s belief that internal rate of return — not traditional time-weighted return — is the superior measurement of performance. “IRR holistically looks at the time horizon of interest and considers all fund cash flows. Unlike time-weighted return, IRR captures the impact not just of managers’ investment decisions, but also of when those decisions are made,” said Stella.

To put IRRs in proper context, Cambridge recommends that investors review IRRs alongside cash-on-cash multiples such as those for distributed capital versus paid-in capital and total fund value versus paid-in capital.

Benchmarking mature funds

Stella noted that Cambridge Associates finds it relevant to benchmark mature funds within a broader private equity portfolio. “We’ve done considerable research that shows it takes private equity funds an average of about six to eight years to settle into their final performance quartile, and that the fund’s quartile placement can vary significantly during that period,” he said. “Our most recent research showed that over 80% of funds that we looked at placed in three different quartiles over their lives until they finally settled into their final ranking.”

This observation, in turn, generated a key insight: When assessing the performance of immature funds — those less than six years old — investors should be more cautious and rightly question whether these funds’ performance is meaningful yet. Investors could then do a deeper dive into the underlying portfolio data to see how the funds’ investments performed on a gross basis.

Doing so, Stella said, would give investors the perspective to say “OK, I know the performance, I know it’s a younger fund. And I also know that the fund’s performance might not be meaningful for another few years, so I can take the latest return numbers with a grain of salt.”