414: Private markets: myth vs reality

This podcast is intended for investment professionals only. All investing involves risk. Every asset class has a story. Equities are the engine of long-term growth.

Bonds are the ballast. And private markets, they come with their own narrative. Patient capital, complexity premia, and access to parts of the economy public markets can't reach. And like all market narratives, there are real truths and a few assumptions that don't always get challenged.

I'm Sharka Howell's content manager and I'm joined by Rebecca Burgess, private markets asset allocation investment specialist and Lushan Sun, head of cross-asset private markets research. They're going to unravel some of the most pervasive myths in private markets. But before we get into the conversation, I'm curious to know what's the view on private markets you've changed your mind on over the years. Lushan, let's start with you.

Great. Thanks, Shaka. Great to be back on the pod again. So what's one of the on-private markets that I've changed my mind on over time?

I think for a long time, private markets was considered this tiny sibling to the public market. For example, the public global equity market is about $160 trillion, and global private equity market is probably only a tenth of that size. So the assumption, the widely held view has always been that, you know, public market is a dominant way to access any new investment trends or investment opportunities. Well, that might have been true at an overall level still, but in recent years, private markets are definitely playing a very active role in areas like digital infrastructure, utilities investments, residential housing, for example.

Now, we think in sectors where there's a long-term horizon that is needed by investors, but a strong structural tailwind supporting the asset class, private markets actually really puncture about their way. They are leading the way in terms of capital deployment. Okay. And Rebecca, what's the view that's changed your mind over the years?

Yeah, thanks. Thanks for having us on, by the way. I would say how we think about the role of private markets in a portfolio context. So in the past, there's definitely been a focus on that return aspect, so that capturing the illiquidity premium.

And while that's clearly part of the story for clients, I'd say it's definitely become less central in how we need to think about it. And increasingly, it feels that it's more about what these assets provide. So if you look at areas like infrastructure, natural resources, or real estate, they're relatively only small parts of the public indices. For example, around 15% of MSCI acquiesce.

But actually, they're a much larger part of the real economy. So I think that shift has really gone beyond just how we size private markets as a standalone allocation and more towards what exposure we actually want to those underlying assets and what impact can our investment actually make. Okay, thank you. Rebecca, let's start with probably the most common myth you hear, that illiquidity is a structural problem for defined contribution investors, that it's something that should be minimized or avoided altogether.

Is that a fear that's justified or are we misunderstanding what risk really looks like in long-term investing? So I think to start off, we'll just say when we talk about illiquidity, all we really mean is the reduced ability to access or redeem capital at short notice, which is a feature of many private and market investments. But whether that's really a problem is another thing entirely. So I'd say illiquidity risk is very much horizon dependent.

What looks like constraint over the short term may be entirely appropriate and actually even beneficial for investors and can actually protect them in the long term. Now, when we think about the DC market for UK pension schemes, they have very predictable, stable cash flows, and this naturally supports a private market's allocation. Illiquidity can be a challenge if it is managed or even designed badly in a portfolio context, but in the long-term savings, it's actually a feature of private markets and not something that we need to just think about removing So actually illiquidity premium can enhance long outcomes when it is paired with the right pacing and right governance framework So what really matters in terms of planning do you have the right mix of open funds and close funds have you sized your position correctly, and is there a governance framework to support this, rather than just avoiding illiquidity altogether?

Okay, so the next myth comes up a lot, particularly from people with a public markets background. And it's the argument that private market returns appear smoother simply because assets aren't marked every day. Lushan, in your view, is that a fair perception? Typically, private market assets are formally valued on a quarterly basis.

Interquarter estimates might be available, but generally they are valued properly once every quarter. So, yes, you could argue that in appearance they do appear smoother, but that simply is the nature of the valuation mechanism. And this also enables private markets to look through any inter-quarter monetivities, which are something that the public market assets have to go through. Contrary to popular opinion, private market valuations are not just made up by the managers.

Quite often, the managers seek independent valuations from a third party. The third party would then base their valuations on underlying fundamentals of the assets, for example, income generation, profitability, growth trajectory, etc., etc. And they will also be guided by recent transactions of similar assets to get a sense of, you know, if this asset came to market today, what kind of price or valuation we might achieve.

Now, these metrics don't always change hugely quarter on quarter. If you think about a medium-sized privately owned company, its profitability, it might get up and down over time, but it's not going to hugely change in between a three-month period. And that does contribute to a more stable valuation and provide immunity to sentiment-driven frenzies I mentioned earlier. From a behavioral perspective, we think a smoother path is beneficial for DC schemes.

If a member is, for example, constantly checking their pension pot on the internet and they're influenced by short-term market noise, more stable asset valuations can help reduce the risk of the members constantly trading in and out of funds, which can generate high transaction costs without necessarily any benefit to their long-term returns. Okay, Lucian, you've mentioned short-term market noise and sentiment-driven frenzies. So let's stay on the topic of volatility here. We've seen some turbulence in private credit, and there's been a lot of persistent negative headlines.

Can you talk us through the risk picture? And has this actually been a useful stress test for private credit? Yes, and incredibly topical at the moment. I think this is a good time to bust another myth, which is that private market asset valuations only ever go up.

Now, the current turbulence in private credit is a really good example of why this is not always the case. The sub-investment grade part of private credit, commonly known as direct lending, has seen valuation markdowns over the last couple of quarters, as managers become more cautious on the potential impact of AI disruption on some of the software companies in their portfolios. Now, we know this because one component of a direct lending market, the Business Development Companies, or BDCs, they are required to file quarter reports with the SEC in the US, which disclose valuations of the underlying assets.

We know that in Q1, the valuation on average declined by 4% from the BDC filings. Now, these losses are not yet crystallized because most of these losses are still performing and paying back interest. Default rates have also been ranged about over the past few quarters. But we are seeing the managers becoming more proactive and are starting to make provisions for potential future losses.

Now, you ask the question of whether I think this has been used for stress tests for private credit. I think the answer is definitely yes. I think it has been really useful for direct lending market to experience some stress in this current cycle. This has really been the first proper test since the asset class became mainstream over the last 10 to 15 years.

We are probably going to see increasing bifurcation while diversified portfolios that were underwritten properly prudently should be resilient and ride out of the storm Whereas portfolios with a high concentration of software loans originated in a zero rate environment with high leverage are probably going to be more challenged Changing the gears a little bit. So the third myth that we'll tackle is that private market are a one decision game where you find the silver bullet fund and you're done.

So this looks like it could be an appealing idea. Rebecca, is that a myth that needs to be dismantled? Yeah, that definitely sounds appealing, Zaka, but what we need to remember as a starting point, that is that concentrating in a single manager or single fund is effectively a single bet. And that same logic that applies in public markets is really essential here in public markets, but arguably even more so.

and one of the reasons for that is the level of dispersion in returns. So our research shows and general research kind of accepted in the industry shows that the difference between top and bottom performing managers tends to be much wider in private markets so the outcomes are far more dependent on strong access to opportunities for example as well as manager selection. In fact from our research beyond manager selection one of the biggest drivers of consistent long-term success is vintage diversification.

So where we're committing capital across different market cycles and not just picking the right moments. You can't just invest and leave is definitely one of our takeaways. But investors can benefit from multiple strategies and multiple managers. They create multiple sources of growth and multiple sources of cash flows.

So we're not relying on any single exposure to deliver outcomes for us. Thank you. Lucianne, what would you add to that? Well, there probably is some truth to this myth.

If we go back 10 or even five years, private market investing was dominated by what we call close-ended funds. So you commit at the beginning of the fundraising process, the fund then closes, and then you don't really have much choice of getting money out until the managers start to distribute income from the investment proceeds and then before winding the fund back up. So there you really only have one decision, and that's do I commit to this fund or not? Once you have committed, you're basically locked in for the life of a fund, which is generally seven to ten years, but can actually be longer.

Now, the private market industry has developed a lot in the past few years. Not only do we have more semi-liquid funds where you're able to redeem assets at periodic frequencies, the secondary market has also grown rapidly and that's where investors have the chance to offload their stake in close-ended funds, you know, trade essentially with another investor if they want to get out before the fund is fully wound up. Then this means investors have a lot more decisions to make.

And it is now a much more continuous investment and process throughout a particular fund cycle. But it also gives investors a lot more flexibility, as we've just discussed. Let's end on what might be the most seductive myth of all, that private markets are simply a higher return version of public markets. and that outperformance is the primary reason to own them.

Rebecca, is chasing outperformance the right frame for this? I would say the real benefit is the steady, repeatable contributions to long-term growth that it can provide. So we're not talking about every component needing to shoot the lights out against public markets. And this is very much how we think about a private markets portfolio.

So different private market strategies, different asset classes can deliver fundamentally different things. so some can deliver income inflation linkage or growth and these very much need to be understood on their own terms and what they bring to the portfolio and then in terms of the risk and return and liquidity trade-offs that they all provide and this is all very different across strategies so for example and we have a kind of fair few we can talk about but affordable housing for example may have a lower headline return than say it's built to rent kind of residential counterpart, but delivers a far higher tenant stability and therefore greater resilience in market downturns, which could be beneficial for the portfolio.

Within infrastructure, we already mentioned digital infrastructure today but it offers a high growth potential strong demand driven upside whereas core infrastructure tends to deliver potentially lower but more stable inflation and cash flows, which can be very attractive. So rather than thinking about private markets as a source of consistent outperformance, it's perhaps more useful to think about how these different components combine to support the overall objectives of your allocation or of your portfolio.

Yeah. Luciane, would you like to add anything? I think it's worth just saying that over the past 20 years, private markets have delivered very strong returns and generally outperformed public markets after fees. The extent of that performance, of course, depends on what public benchmark comparator you use.

But generally, private markets have delivered outperformance over the last 20 years. I think that's important to note. Now, Rebecca has already alluded to this. The right question here is not whether private market beat public markets is whether a given strategy delivers what it says on the tin and how it contributes to an investor's overall investment outcome.

The biggest difference between public and private markets is that there is no index to follow in the private markets. So alpha generation therefore comes down to asset selection and manager's skill. Now that's really important especially in today's market conditions where the environment is so much more complex and moving at at a very quick pace. Dispersion between strategies in private markets is also much higher.

So, you know, you can get top performers that will deliver super strong returns and your local top performers delivering really, really bad returns. So there is scope to generate incredibly good returns over the long term for investors that make the right course. Four myths, four different realities, and the thread running through them all is that private markets reward patience, rigor, and intellectual honesty about what you're trying to achieve. Rebecca, Lushan, thank you.

For listeners who want to go deeper, links to the team's research can be found on our blog and we'll add the link to the show notes. This is LNG Talks and we'll see you next week with a new episode. As a reminder, this podcast is intended for investment professionals only and shouldn't be shared with a non-professional audience. The views expressed in this podcast are those of LNG's Asset Management Division as at the date of publication.

This podcast is for informational purposes only and we're not soliciting any action based on it. The information discusses general market, economic or political issues, or industry or sector trends. It does not constitute research or investment, legal or tax advice. It is not recommendation or reimbursement to buy or sell securities or pursue a particular investment strategy.

Assumptions, opinions and estimates are provided for illustrative purposes only. There is no guarantee that any forecast made will come to pass. No party shall have any right of action against LNG in relation to the accuracy or completeness of the information contained in this podcast. Where this podcast contains third-party information, the accuracy or completeness of such information cannot be guaranteed, and we accept no responsibility or liability in respect of such information.

Not for distribution to any person in any jurisdiction where such distribution would be contrary to local law or regulations. Copyright 2025. Legal and General Investment Management Limited is authorised and regulated by the Financial Conduct Authority. Unless otherwise stated, references herein to LNG, we and us are meant to capture the global conglomerate that includes in the European Economic Area, LG Managers Europe Limited, authorised and regulated by the Central Bank of Ireland as a USIT management company pursuant to European communities undertaking for collective investment in transferable securities regulations 2011 as amended and as an alternative investment fund manager pursuant to the European Union Alternative Investment Fund Managers Regulations 2013 has amended.

In the USA, Legal & General Investment Management America Inc., a US SEC-regulated investment advisor. In Japan, Legal & General Investment Management Japan KK, a Japan FSA-registered investment management company. In Hong Kong, issued by Legal & General Investment Management Asia Limited, which is licensed by the Securities and Futures Commission.

and in Singapore issued by Elgium Singapore PTE Ltd, company registration number 202231876W, which is regulated by the Monetary Authority of Singapore. For full terms and conditions, please visit our website. To find more content, you can check us out on LinkedIn or on our website.