Private markets have been in the limelight over the last few months with a big push to open those investments to a larger pool of investors. There are conflicting arguments around whether private credit or equity investments should be made more widely available, but the current trend has those in favor of expansion winning the debate.
Private markets have been in the limelight over the last few months with a big push to open those investments to a larger pool of investors. There are conflicting arguments around whether private credit or equity investments should be made more widely available, but the current trend has those in favor of expansion winning the debate. It’s likely that with the news coverage surrounding private markets, clients will be asking questions. Private market investments present a different level of risk than normal, particularly due to differing regulatory standards and pricing methods.
One of the touted benefits of private investments is that they have less volatility. This is more of a half-truth than many would like to admit as the “lower volatility” is in part due to private investments not needing to be marked to market, particularly in times of distress. As these investments become more widely available and presumably more liquid, prices will be much closer to a marked to market framework. Secondly, regulatory standards may change rapidly due to private markets opening up, but a recent example shows that things can get quite gray in the private market space. Tricolor Holdings, a subprime auto lender, filed for Chapter 7 bankruptcy with its asset-backed securities eventually trading as low at 12 cents on the dollar less than two months ago. Major banks like JPMorgan (JPM), Fifth Third Bancorp (FITB), and Barclays (BCS) were noted to have exposure. While Tricolor’s business model was very risky as they focused on marketing to customers excluded from traditional banking systems, like undocumented immigrants (68% of its borrowers had no credit score and over half didn’t have a driver’s license), the real undoing of Tricolor was its alleged fraud involving pledging collateral more than once to different lenders (Bloomberg). While this is a single case, it does show how fast things can change in the private credit and equity markets.
While private markets open the doors to a lot of unknown and potentially higher volatility than expected, this is also what drives the prospect of greater returns. There is not much price history on some of the new private credit/equity ETFs that have recently hit the market, but there are publicly traded stocks that are heavily involved in private markets that can give us some insights into how direct exposure may unfold. For some of the big players in the space displayed in the image below, only one has an acceptable technical attribute rating, Carlyle Group (CG). The recent performance of these stocks has been less than ideal with an average one-year return of -17.90% while compared to the S&P 500’s return of 14.08% over the same period. However, on the longer three-year time frame, one can see the allure of private market exposure. The average return of the six stocks is in line with the SPX over the last three years, but there are some big winners like Apollo Global Management (APO) and KKR & Co. (KKR) which each gained over 100% in the last three years. Don’t forget, that includes the less than -20% one-year return for both APO and KKR. Overall, private markets offer a unique opportunity for investors. Despite the risks being higher than many advertise, the general investment rule that higher returns require higher risks is still true and managing that risk is why having a process when evaluating investments (public or private) is paramount.
