Private market strategies targeting private wealth and retail investors might have liquidity features that are a mismatch with the underlying assets or produce a drag on returns and alter strategies’ risk profiles, bfinance warns
With private market strategies, including private equity and private credit, becoming increasingly accessible to the private wealth space, new products might include liquidity features that substantially change a portfolio’s risk profile and return characteristics.
In a recent report, “Private Markets for Private Wealth: Democratisation vs. Retailisation”, global investment consultant bfinance warns that to cater for the higher liquidity demands of private wealth investors, some of these newer products might end up having inappropriate structures.
“Liquidity has become the most visible innovation in the retailisation of private markets and evergreen structures are the flagship. Importantly, liquidity can affect product integrity and performance,” the authors of the report write.
Liquidity has become the most visible innovation in the retailisation of private markets and evergreen structures are the flagship. Importantly, liquidity can affect product integrity and performance – bfinance report
Many of the new private wealth-focused products are evergreen strategies, having no fixed end date, unlike traditional private market strategies, which tend to be closed-ended funds, bfinance says.
A key benefit of evergreen structures is investors don’t have to deal with the J-curve of capital calls seen in closed-ended funds.
But there are several trade-offs, including a liquidity mismatch of the fund’s liquidity features compared to its underlying assets, as well as a dilution of returns from high cash buffers. Some funds hold up to 25 per cent in liquid assets, leading to a potential performance drag of 70 to 100 basis points.
Yet, a recent bfinance survey shows more than one-third of wealth managers are increasing their use of open-ended or semi-liquid private market strategies on the back of client expectations.
“In pursuit of broader distribution, liquidity terms risk exceeding what underlying investments can reliably support. This introduces potential friction between investor expectations and fund reality,” the authors of the report say.
A Closer Look at Private Credit
Private credit has attracted much interest from investors in recent years, as these assets have produced returns close to those of equities at a lower risk. As a result, a number of new private credit vehicles have been launched to cater for private wealth investors.
Olivier Cassin, Head of Investments & Research at bfinance, says that although semi-liquid fund structures, which have limited to no liquid assets, are more established in private debt than in private equity, the market continues to see a wave of new products offering enhanced liquidity features, many of which remain untested over time.
Newer offerings targeting retail investors are beginning to include more generous liquidity features. However, this is often achieved by incorporating more liquid components such as broadly syndicated loans, high yield bonds, or even money market instruments, which materially alter the portfolio profile – Olivier Cassin
“Newer offerings targeting retail investors are beginning to include more generous liquidity features,” he tells [i3] Insights. “However, this is often achieved by incorporating more liquid components such as broadly syndicated loans, high yield bonds, or even money market instruments, which materially alter the portfolio profile.
“As such, the concerns raised in the report are indeed relevant to private credit. These products require close scrutiny to assess whether the liquidity offered is sustainable and aligned with the underlying asset base,” he says.
Increasing Complexity Might Lead to Bad Choices
The rapid expansion of evergreen and semi-liquid products, particularly in private equity, private debt, and multi-private asset strategies, has introduced a wide and increasingly complex array of structures, each with distinct features and liquidity mechanisms, including soft locks, gates or slow-pay mechanisms.
This complexity makes it harder for private wealth investors to choose an appropriate vehicle.
“The risk of selecting a poorly designed or mismatched product is significant, particularly for less experienced investors, and could result in disappointment, gated redemptions, or unexpected NAV (net asset value) discounts,” Cassin says.
“While this is not currently viewed as a systemic risk, the growing popularity of these structures may lead to broader disillusionment among investors if expectations are not managed carefully, especially in stressed market environments,” he says.
Questionable Practices in Retail Products
[i3] Insights understands that in some existing private credit retail products, managers have been engaging in not just overly complex and opaque fee structures, but also outright questionable practices. For example, there is anecdotal evidence that managers have swapped assets out from one fund to another in an effort to make the risk profile more palatable to investors.
Cassin responds that while the managers bfinance selects undergo a rigorous forensic due diligence process, with particular attention paid to deal allocation practices, conflict management, and valuation methodologies, he also acknowledges some inappropriate practices do seem to exist in the retail industry.
Questionable practices can exist, particularly in semi-liquid structures where carried interest is calculated on NAV rather than on realised proceeds, unlike in closed-ended funds. This creates incentives that must be carefully scrutinised – Olivier Cassin
“Questionable practices can exist, particularly in semi-liquid structures where carried interest is calculated on NAV rather than on realised proceeds, unlike in closed-ended funds. This creates incentives that must be carefully scrutinised,” he says.
“These dynamics highlight the importance of robust manager selection. For semi-liquid strategies in particular, ensuring proper governance, transparency, and alignment of interest is essential to protecting investors.”
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[i3] Insights is the official educational bulletin of the Investment Innovation Institute [i3]. It covers major trends and innovations in institutional investing, providing independent and thought-provoking content about pension funds, insurance companies and sovereign wealth funds across the globe.