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Looking past the illiquidity problem in private markets

LONG READ: When it comes to private market investments illiquidity is a problem. But what if it was viewed as a positive feature in times of stress?

Looking past the illiquidity problem in private markets

LONDON - After several high-profile problems surrounding illiquid assets in funds claiming to provide daily liquidity, many would be forgiven for being apprehensive about diving into strategies that offer no liquidity whatsoever.

One only has to remember the dramatic downfall of Neil Woodford, who shut his eponymous firm last year after being faced with a wave of redemption requests due to souring investments, which he struggled to meet because of his illiquid holdings.

There is also the fallout experienced by H2O Asset Management due to its illiquid debt exposures, which eventually led to the company suspending trading on several funds.

But, as many experts, and the former head of the British financial regulator Andrew Bailey previously said, such cases should not turn investors away from illiquid asset investments for good.

The up-side to illiquidity

It is true that alternative assets, particularly private market investments, will not be appropriate for all investors, which is why it is up to financial advisers and wealth managers to figure out what would be suitable to their clients’ needs.

But, as private investors increasingly look to gain access to alternative funds, such as private equity or private debt, spurred on by higher expected returns, it is important to rethink the approach to liquidity.

As Cliff Asness, founder of investment manager AQR, wrote last December: ‘Liquid, accurately priced investments let you know precisely how volatile they are… what if many investors actually realise that this accurate and timely information will make them worse investors as they’ll use that liquidity to panic and redeem at the worst time?’

Just two months after Asness penned his comment, on Thursday 20 February, stocks suffered a sudden sell-off, following increasing market fears about the spread of the coronavirus.

Many investors would have been tempted to get out then, with some actually selling their assets as the panic set in, but such short-term thinking can be detrimental, as investment groups like to warn clients time and time again.

Looking for liquidity

What if illiquidity was thought of as a good thing, allowing investors to stay put at a time of significant volatility? Still, questions around liquidity remain frequently asked by clients looking to increase their allocation to private capital in their portfolios.

The problem lies with the attempt to create liquidity where it doesn’t exist according to Jason Proctor, founder of alternative investment platform Truffle Invest, which offers access to private market funds from as little as €5,000. 

‘We’ve seen that in the past, and they offer liquidity during good times but when investors want it it’s not always there,’ he said.

Leo Kelly, chief executive officer of Verdence Capital Advisors, agreed. ‘There have been attempts at doing private equity funds with some sort of hybrid structure that provides liquidity.

‘Our experience is when you mismatch the liquidity of the underlying investment with the liquidity of the fund itself that can work fine for a period of time, but at a moment of severe stress those funds unwind very quickly. Sometimes investors and advisers get too cute to solve that problem, that creates a bigger issue.’


For Kelly, it is fine to allow retail investors access if they are educated, they understand what they own, and they understand the pros and cons of the investment. Trying to remove illiquidity should not be the answer.

‘Illiquidity is the reason you get a premium return over time. I think if any investor is going to invest in the private equity market, they need to understand their money is going to be tied up for a period of time,’ he added.

Proctor said not having the option to sell is not always bad from a returns perspective, highlighting a growing understanding that liquidity is not always as beneficial as people think it is.

Still, it is crucial to have a regulated financial adviser as an intermediary for private investors investing in private market funds, as they will have a better view of an investor’s liquidity needs, he warns.

Where to look in a search for liquidity

For those who really do require liquidity, there are products that are designed for private investors which offer it – such as vehicles which have a portion of the fund in private equity and the remainder in more liquid assets that can be sold down – but the challenge is investors are not getting real private markets exposure, Proctor said.

Concerns around the risks of widening the access to private market funds once again have been thrust into the spotlight again recently as France’s state-backed investment bank BPI launched a new fund – structured as a special purpose vehicle – that will own a 5% share of a portfolio of 145 French private equity funds that BPI invested in between 2005 and 2016.

This way, the bank is looking to open up this often lucrative but difficult to access asset class to retail investors, who can buy shares in Bpifrance Entreprises 1 with a minimum investment of €5,000 and a maximum of €75,000. Investors will be locked in for six years and will not be able to make withdrawals during this time. 

The move follows a recent change by the US Securities and Exchange Commission to its definition of an “accredited investor”, so that it is not solely based on wealth but also on knowledge and experience of markets.

In addition, the US regulator last year revealed that it was exploring how to increase access for retail investors to private companies, with a senior director calling for changes so individuals can boost the returns of their pension portfolios.

The drive to democratise

Online platforms such as Truffle Invest in the UK, Moonfare in Germany and iCapital in the US, have popped up around the world trying to “democratise” private market investments. There is no shortage of demand from both retail clients and ultra-high net worth investors, but the problem of illiquidity remains.

In Proctor’s view, the institutional world can offer solutions. While he believes there will be more innovation to come, he points to the secondaries market – where investors in closed-ended private markets funds can sell their investment to other interested investors with the permission of the fund manager – as an example of what could be achieved for individual investors as well.

‘The secondaries world is very well established – if you are an institutional limited partner (investor in a fund), it is very easy to initiate a process. It is that model which is more likely to provide liquidity to private investors in the near term,’ he said.

‘It’s obviously very different - comparing hundreds of thousands with tens of millions - but there are ways of solving that. One is the efficient structuring of the original feeder vehicle. We have been developing approaches for easily clearing investors’ participation in feeder vehicles, making the subscriptions and execution process easier and thereby facilitating secondary activity more easily.

‘The onus may fall on the private banks and wealth managers to be market makers to their own clients within these feeder vehicles. We’re not talking about writing blank cheques but deploying a bit of balance sheet capital to grease the wheels of an internal secondary market might be the solution.’

Not always appropriate 

In the US, iCapital partnered with Nasdaq last year to provide such liquidity to advisers and their high-net worth clients through an integrated secondary marketplace.

The group’s chief executive officer Lawrence Calcano said the firm is ‘trying to find ways to make the asset class as institutional as possible’. However, he admits that for those who have short term needs for cash or can’t manage the illiquidity, the private market products remain inappropriate. 

Some are sceptical.

Connection Capital, where Claire Madden is a founding partner, gives ‘elective professional clients’ the opportunity to invest in alternative opportunities in units of £25,000.

And for Madden any move to open up the doors of private markets to a wider investment base needs to make sure that investors who are channelled into such funds can withstand the risk of the asset class and understand what they’re getting into.

Per Strömberg, professor of finance and private equity at the Stockholm School of Economics, agreed. He is not sure that opening up 401k retirement plans for example to private equity investments is “such a smart thing to do”.

‘I think that this is an illiquid asset class, so either you are going to lock up your money, or you’ll do some set ups that allow more liquidity but that’s going to go hand in hand with returns not being as good.’

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