Why CIOs Access Private Markets

“Private credit: Smoke, yes, but how much fire?” - Jim Reid

The current torrent of headlines around the lack of exits in Private Equity and Software/redemption risks in Private Credit might make it feel like Asset Owners have been caught up in Illiquid asset marketing hype. That misses the point about the role of Private markets in a long-term portfolio.

Background

Through the conversations I have had with CIOs from the UK and US alongside my co-host Sean Thompson, the subject of illiquid markets has come up frequently. As opposed to the marketing language of risk-free premium, tight covenants, and no mark-to-market volatility, CIOs utilise private markets to deliver a risk/return profile one cannot achieve in the public markets alone. The term private markets is so broad as to be descriptive but not useful in asset allocation. It includes seed stage funding to growth, to LBOs, to hybrid capital, to senior secured direct lending, infrastructure, real estate and infrastructure to name but a few.

The role of private assets in portfolios

To run a balanced portfolio, public markets are not enough.

1. The global indices so heavily overweight US stocks, and those US stocks are so heavily concentrated in a handful of tech titans that the market weightings and importance to GDP are too divergent. There are skews too in debt indices. Indices construct portfolios around the last generation of winners, whereas CIOs wish to structure around the next generation.

2. By sticking solely to public markets you exclude exposure to vast swathes of the economy. Many mid-cap companies for disclosure or logistical reasons choose to finance privately. Simon Pilcher from USS said it crisply, “If you’re only investing in public markets, you’re constraining yourself to about 13% of the corporate [debt] universe.”

3. CIOs need to meet a return target, or a set of payments in the future. Many of these future liabilities are index-linked or to a specific currency. There are some assets only available in the private markets that have the right cash flows to help them match assets to their liabilities. Rob Groves captured this with: “We need assets tailored to our liabilities.”

4. Diversification is the final key benefit. Private markets can bring unique access to real estate, infrastructure and venture/growth to name but a few. Each of these have different risk/return characteristics that can be additive to a portfolio.

The current challenges in Private Markets

Even the biggest cheerleader of private markets cannot miss that the sentiment is negative.

Traditional Private Equity exits have stalled and in many cases sector valuations peaked in 2020-2021. The result is that many PE platforms cannot monetise stakes at attractive levels in the current environment. For Asset Owners, this means lower and delayed payments, hurting IRRs. This also means that cash has been slower to trickle back to investors, and some of them need that cash to meet future capital calls for other fund commitments. There has been some innovation around that. Fund level financing solutions release cash from funds, secondary funds to provide liquidity to illiquid stakes and continuation vehicles to take on investments that are not ready to be monetised.

Private credit, which had huge growth in that same zero rate environment is now five years later finding that refinancing some businesses is a stretch. Software is an example, where the expectation was that once a company integrated a particular software into its business, it was unlikely to shift for a long while. That switching cost has gone down substantially given the capability of AI to create better and cheaper alternatives.

No asset classes are immune from a search for yield and as Jim Reid said in his 23rd Feb piece “Private capital experienced fast growth during the ‘cheap money’ years and remains opaque.” The feast and famine nature of the credit cycle will impact both public and private markets. Our CIO interviews and general market narratives highlight three challenges today in private markets:

1. Price intransparency

As Gerald Chen Young reminds us “Just because you don’t see the marks day to day doesn’t mean the volatility isn’t there.” Chetan Ghosh went on further to say “Stale marks are a camouflage. The risk hasn’t gone away.”.

2. Rating shopping and governance risk

Internal ratings or ratings that have been privately negotiated risks a fresh pair of eyes looking negatively at them and thinking that some investments should carry a lower rating. Ratings are only as good as the governance behind them. Price uncertainty increases further where ratings are not trusted.

3. Unrealistic liquidity promises to investors

Without price transparency it is risky to promise liquidity to investors. As with many previous sector stresses, the mismatch in liquidity of the assets and liabilities can cause a sharp unwind in an illiquid and distressed market.

How CIOs and their teams model private assets

These issues are well known and CIOs focus on how to price, size, and manage those risks. Going back to the original premise, private markets help CIOs meet their investment objectives, but traditional strategic asset allocation frameworks must be adapted when assets are not liquid.

Whilst the first-order decision of which manager to invest with and expected returns are something that will always have a large impact into allocations (and that's quite subjective), there are some important modelling assumptions that can help private markets fit within long-term portfolios.

1. Accounting for price intransparency

Comparing historic volatility and correlation of market-priced investments versus market-unpriced assets is an apples to oranges comparison. There is no one-size-fits-all solution to this. Examples of approaches are:

• Use public-market proxies for volatility/correlation analysis (e.g. listed REITs, infrastructure companies, HY credit spreads)

• Applying volatility or correlation skews to account for the difference.

2. Accounting for liquidity — the ability to act, not merely transact

Instead of assuming assets can be sold at “fair value, immediately” one could model:

• Time‑to-cash (and at what haircut) under normal and stressed conditions, including manager‑gated redemption windows.

• Liquidity tiers, so that private assets are not needed for sale or collateral posting.

• Cash timing risk, including situations where distributions arrive after new commitments are due — creating funding stress.

3. Accounting for the loss of optionality

Illiquidity should not only be framed as ability sell under stress. The ability not being able to pro-actively reduce outperforming private markets exposure has a cost too. Rob Groves’ observation guides this part of the modelling: “It’s the ability to improve the portfolio when opportunities arise.”

• Treat liquidity as an option in public assets or marking its absence as a cost in illiquids.

• Running opportunity‑cost models: what could the portfolio have earned if we could rotate into stressed assets at the right moment? How much should the illiquid portion compensate for that risk.

4. Sizing private markets exposure through scenario analysis

CIOs do not size their private markets exposure based on historical or marketing IRRs. They are sized based on how the whole portfolio behaves across future states of the world. Examples of scenarios are:

• Upside/Base cases: steady distributions, refinancing success, stable valuations.

• Downside cases: extended hold periods and/or exit valuation haircuts

• Macro regime shifts: stagflation, higher‑for‑longer rates, AI disruption to cashflows, geopolitical fragmentation.

The convergence between public and private markets

The once‑clear boundary between public and private markets is dissolving. Some private markets are showing signs of transparency.

• In Equity-land many Pre‑IPO companies run semi‑public investor processes, and price discovery rounds through secondary marketplaces.

• In Credit-land, once thought of entirely as buy‑and‑hold illiquidity, is becoming more tradeable especially in investment-grade land.

This convergence should challenge the binary of public and private into a continuum but also put pressure on illiquidity premia, deal structures and management fees.

So what?

1. CIOs allocate to Private markets as a way to overcome the access limitations and exposure skews of public markets and enhance the ability for CIOs to meet investment objectives.

2. Some of the normal asset allocation modelling techniques are not appropriate for illiquid assets as they do not price in volatility or correlation appropriately.

3. Another important consideration is liquidity. This is optionality to change your mind when things are out of balance, or equally important but often overlooked, the opportunity to sell outperforming assets to allocate to another attractive area. Liquidity should be priced accordingly and an illiquidity premium should compensate holders for that.

4. CIOs size private exposures through a total portfolio approach that includes liquidity stresses. This will ensure that cash can be paid out when needed without needing to access illiquid assets to meet collateral calls.

5. The convergence of public and private markets is happening. This has made the analysis of illiquidity, return and fees into more of a continuum.

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