Private Markets Mythbusters Series: Part II

1

Private Markets Mythbusters Series

You can't control the cycles, but you can control your nerves

Why a continuous investment strategy - especially in times of uncertainty - is the best remedy for volatile markets

After assessing the ability of private equity buyouts to generate returns across market cycles, we continue with our Private Markets Mythbusters Series, this time zooming in on periods of higher economic uncertainty and market volatility.

Despite investment data showing that strong performance in private markets often emerges from times of uncertainty, such periods appear to coincide - somewhat counterintuitively - with a reduction in investor activity that ultimately leads to investors missing out on returns, and obtaining lower diversification and less stable distributions.

This investment pattern might be the result of behavioral

biases rooted in the widespread myth that private market returns are pro-cyclical1. Or even the consequence of investors being tied to overly restrictive (self-imposed or regulatory-driven) asset allocation frameworks and/or the lack of distributions seen during more volatile times.

In this paper, we will explain why periods of increased volatility can generate the most attractive buying opportunities in private markets. We will show how investors can take advantage of these opportunities by employing a simple playbook centered on investment

1 Robinson, David T.; and Sensoy, Berk A., "Cyclicality, Performance Measure- ment, and Cash Flow Liquidity in Private Equity", Journal of Financial Eco- nomics (December 9, 2015). Brown, Gregory; Harris, Robert S.; Hu, Wendy; Jenkinson, Tim; Kaplan, Steven N.; and Robinson, David T., "Can Investors Time Their Exposure to Private Equity?", NBER (February 2020).

continuity and a flexible allocation framework. Using an example institutional investor portfolio and over 20 years of private markets cash flow data as a case study, we will also demonstrate how this approach can strengthen portfolio construction, as it results in improved performance and more stable distributions throughout market cycles.

Bad times, great returns

"History may not repeat itself. But it rhymes". The quote often attributed to Mark Twain seems fitting for a comparison between the Global Financial Crisis (GFC) and the current uncertain macro regime.

2.6x

Post GFC returns achieved by top buyout funds

Back at the height of the GFC, investor commitments to private markets dropped by approximately 60%. This was followed, however, by top managers delivering some of the best private equity vintages of the last two decades - 2.6x returns2 for 2009 and 2010 vintages, compared to 2.1x for the six years before.

Fast forward to today and the latest fundraising data shows a c.30% decline from 2021 levels.3

Still, we believe it is important to emphasize that the current macro environment - defined by higher interest rates and sticky inflation, stricter lending

1. Measured in Total Value to Paid-In Capital (TVPI).
2. Aggregate private capital fundraising as of December 2023. Source: Preqin (2023).

Private Markets Mythbusters Series You can't control the cycles, but you can control your nerves | February 2024

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Crises yield good vintages

Global private equity fundraising and top-quartile buyout funds performance

1200							Low interest
		Post
		Expansion & Boom	Post GFC		rate period
1000	dotcom		2.6x	Post EU	2.1x
	2.1x
		bubble
		2.6x				debt crisis
	800				Normalization	2.4x
						NetTVPI
USDbn						2.14x
600
	400
	200
	2000	2004	2008	2012		2016	2020

Chart shows global private equity fundraising in 2000-2023 and performance of top-quartile buyout funds measured by net total value to paid-in capital (TVPI). Sources: Partners Group (2024); market figures from Bloomberg as of 31 December 2023, Burgiss for net TVPI as of 30 June 2023, Preqin for Private Equity fundraising as of 31 December 2023. For illustrative purposes only.

Uncertain times require nerves of steel

Despite not intending to pursue a pro-cyclical pattern in their commitments, in reality, many investors are tied to the latest market developments when it comes to their investment decisions. Using simple regression analysis, a 1% drop in fundraising for a vintage year results, on average, in a 30 basis point return increase. This means that for 2023, which saw a c.10% year-on-year drop

in fundraising from approximately USD 1.5 trillion to around USD 1.3 trillion, returns could increase by c.3%. The reality of the interplay between fundraising and returns is naturally more complex than that, but these numbers provide some interesting high-level insights.

Anecdotal evidence points to pro-cyclical commitment patterns even among longstanding institutional investors. During the GFC, several high-profile institutions suspended private markets commitments, often citing these three main reasons5:

Lower fundraising, higher returns

Regression analysis of private equity fundraising volumes and returns per vintage year

	100%
	80%
change	60%
40%
fundraising	20%
0%
-20%
-o-Y
-40%
Y
	-60%0%	5%	10% 15% 20% 25% 30%
			Net IRR

Sources: Partners Group (2024); market figures from Burgiss for net IRR as of 30 June 2023, Preqin for Private Equity fundraising as of 31 December 2023. For illustrative purposes only.

standards, and uncertainty about a possible "soft landing" - is creating solid buying opportunities. In environments like this, buyers in private markets typically benefit from a range of factors, including:

• Supply-demandimbalance: coming under pressure from factors such as overallocation, fund maturity and liquidity issues, sellers are drawn to the negotiating table, which can give rise to a buyer's market.
• Illiquid markets' transaction dynamics: illiquid assets typically take longer to transact because of

due diligence, legal work, and the transfer of rights, among other factors. The fact that a sale is less likely to happen quickly can lead to additional discounts during periods of economic uncertainty.

• Extended window of opportunities: the best vintages do not emerge at the beginning of a crisis, but soon after. Looking at the secondaries market during the GFC, for example, we see that high-quality portfolios were sold at very attractive discounts in 2009 and 20104 and not at the peak of the crisis.

4 Source: Greenhill Cogent and Jefferies.

Performance concerns: a widespread (and misleading) belief that private markets would underperform, leading to cuts in exposure.

Distribution levels: with assets held for longer during periods of market stress, distributions to investors declined, making them reluctant to maintain or increase commitments.

Denominator effect: with the plunge in public equity during 2008/2009, the relative share of private

5 See "Harvard: the Inside Story of Its Finance Meltdown", Forbes, 26 Febru- ary 2009; "Harvard endowment falls from $36.9 billion to $26 billion", Harvard Magazine, 9 October 2009; Dan Lefkovitz, "Public/Private Markets", Morning- star magazine, 13 October 2022; "The rise and rise of private markets", McK- insey Global Private Markets Review 2018.

markets investments within portfolios increased. Many institutional investors were forced to reduce or suspend new commitments.

Most of these concerns are still at play in the current uncertain environment, although the denominator effect is less of an issue today given the rise in public equity in 2023. To overcome this, we propose a simple approach that aims to bring clarity to a more complex investment environment and flexibility to handle constantly changing circumstances.

Private Markets Mythbusters Series You can't control the cycles, but you can control your nerves | February 2024

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A simple, yet successful strategy

Drawing upon our experience in private markets portfolio construction built over more than two decades, we offer a strategy that is intuitive, proven and resilient to the unpredictable ebbs and flows of market cycles.

This approach is rooted in consistent commitments to every vintage. We believe this can deliver superior returns, while also improving diversification by vintage year and, as a result, enhancing liquidity. To successfully implement this strategy, however, investors require a more flexible framework around allocation targets.

With the following case study, we take an example portfolio and seek to demonstrate how our approach performs better over time than two of the most

common commitment strategies. We will assess these strategies against returns, liquidity and their ability to fit within allocation guidelines.

Case study of commitment strategies

Portfolio characteristics:

• USD 1bn invested from the year 2000.
• 25% allocated to private markets and 75% to

public markets.6

6 Private markets allocation: 60% private equity / 15% private debt / 25% real assets; public markets allocation: 60% equity / 40% fixed income. Pri- vate markets allocation calculated as NAV from historical buyout vintages since 2000; public markets exposure based on the total return of an initial USD 750m investment. First data point: 01/01/2000 throughout, except for private infrastructure (available from 2012). Returns calculated as IRR since investment start for different strategies. Private markets strategy is based on net cash flows derived from the Burgiss dataset. Distributions from the private allocation are only made after capital calls have been serviced and if there is a minimum of 2% cash buffer in the private markets portion of the

• The private markets portfolio consists of a portfolio of private markets funds based on the Burgiss database, with net cash flows constantly reinvested.

This set-up is applied to the following strategies:

Constant Commitments: the same amount is invested every year, adjusted for inflation, and set to target a 25% private markets exposure.

Market Commitments: this resembles the deployment of an investor committing in line with the deployment pace of the industry.

portfolio. Burgiss dataset: Equity, Debt, Real Estate. Public market portfolio: Global Equities (MSCI World Net TR USD, NDDUWI Index) and Global Bonds (Bloomberg Global Agg., LEGATRUU Index). To provide full transparency, we have conducted this case study entirely using the Burgiss data set. Adding direct, co-investments as well as secondaries content can further enhance the forthcoming results. Further information available on request. Source: Partners Group (2024), Burgiss, Bloomberg.

Rigid Net Asset Value (NAV) Targeting: the investor follows a hard NAV targeting approach, seeking a 25% exposure to private markets and reducing or increasing commitments whenever the allocation exceeds or falls below the NAV target.

Results

As illustrated by the chart on the left, our analysis shows that the Constant Commitments strategy strongly outperforms the other private markets strategies, as well as the classic 60/40 public markets portfolio. The approach generates a performance uplift of 150bps, taking the private markets portfolio to a 14% net internal rate of return (IRR), compared to the 12.5% obtained by the Market Commitments approach.7

Compounding at 14% per year, the Constant Commitments strategy achieves a 6x total value to

Consistent and higher

Returns comparison across different commitment strategies and public markets

Net IRR uplifts from commitment strategies

Private markets strategies vs public markets

Uplift from private markets addition to portfolio

								8	Constant commitments					2.5%
					ps	14.0%
				0b				Market commitments
			10
			+					6	Rigid NAV targeting
												6.7%
							TVPI		MSCI World PME (constant)
		s
	bp						Balanced Index PME (constant)
50		13.0%							4.2%
+						4						Performance boost
							x Net
12.5%														from 25% private
													markets allocation
								2
Market			Rigid NAV					0						Public markets	Public markets
				Constant		2000	2004	2008	2012	2016	2020
Commitments			Targeting			Commitments		allocation	+ private markets

paid-in capital (TVPI) versus c.4x for the other private markets strategies. This is driven by the steady compounding of every vintage year and a more stable distribution profile in the Constant Commitment strategy.

On top of this, a 25% Private Markets allocation increases the net return of a 60/40 portfolio of 4.2% by around 250bps per year to 6.7%. Overall, that's a 60% performance increase.

Through our analysis, it has become clear that both the Market Commitments and the Rigid NAV Targeting strategies lead to pro-cyclical allocation patterns by design, not realizing the full

All calculations based on the commitment strategies described before and evaluated as of 30 June 2023 with investments starting in 2000. Balanced Index PME and public markets portfolio taken as 60% MSCI World (NDDUWI Index) and 40% Bloomberg Global Agg. (LEGATRUU Index). IRR SI for buyout only, with similar results for other asset classes. Net IRR based on Burgiss data for 2000-2019 evaluated as of 30 June 2023. For illustrative purposes only.

7 There is no assurance that similar results will be achieved.

Private Markets Mythbusters Series You can't control the cycles, but you can control your nerves | February 2024

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Commitment fluctuations

Amount committed per year under each strategy

Constant Commitments

	200
	150
m
USD	100
	50

potential of private markets in a portfolio. Besides	Targeting strategy offers a more stable allocation	out on the most attractive vintages (like 2009/2010)
the impact on returns, these patterns generate	profile, yet - if applied "dogmatically" with no active	and avoid concentration (like in 2012/2013).
imbalances in diversification by vintage year, which	portfolio management - it can create significant gaps
will ultimately affect distributions and liquidity	in vintage year allocation due to a "stop-and-go"	We note, however, that investors would need a
and even exacerbate potential issues with the	pattern in commitments.	greater degree of flexibility in their asset allocation
denominator effect.		framework to apply this strategy. This means having
	On the other hand, the Constant Commitment	the ability to remain nimble and deviate from target
The Market Commitments strategy is marked by	strategy delivers a more balanced diversification	levels by c.5% for periods of up to three or four years
prolonged periods of over-allocation, often followed	by vintage year, with greater cash flow stability and	in order to harvest the full benefits of their private
by sharp reversals, resulting in a more volatile	enhanced liquidity. As the comparison of vintage year	markets portfolio.
allocation profile over time. In turn, the Rigid NAV	exposure shows, it also enables investors to not miss

2002

2006

2010

2014

2018

2022

Market Commitments
	200
	150
m
USD	100
	50
	2002	2006	2010	2014	2018	2022

Rigid NAV Targeting

	200
	150
m
USD	100
	50
	2002	2006	2010	2014	2018	2022

Keeping up with the allocation target

Variation in private markets allocation as % of total portfolio

allocation	40%			Constant Commitments	2
			Market Commitments
35%			Rigid NAV Targeting
1
markets	30%		1
Private	25%
				3
	20%
	2002	2006	2010	2014	2018	2022

Constant Commitments: slightly longer period of overshooting, but less

• exposure overall

Market Commitments: exhibits the widest swings due to market

• sentiment-drivencommitment pattern

• Rigid NAV Targeting: close tracking of target exposure led to lower commitments to 2009/10 vintages, which had attractive performance

Vintage balancing

Deviation from optimal vintage year exposure as % of NAV for selected vintages

range	15%				Constant Commitments					3
				Market Commitments					10.0%
10%				Rigid NAV Targeting
allocation
5%																	3.4%
vintage	0%	1			2		1
			0.0%
optimal								-0.3%		2013
-5%												2	Underexposure to 2009 vintage
from
														for Market Commitment and
		-7.0%	-7.1%
deviation					Rigid NAV Targeting strategies
-10%	2009
		1
		Balanced exposure to all	3 Overexposure to 2013 vintage
%	-15%					vintages with c.10-15% of			for Market Commitment and
				NAV per vintage year			Rigid NAV Targeting strategies

Source: Partners Group (2024). For illustrative purposes only.

All calculations based on the commitment strategies described before and evaluated as of 2023 with investments starting in 2000. Source: Partners Group (2024), Burgiss, Bloomberg.

All calculations based on commitment strategies described before and evaluated as of December 2015. Optimal vintage year exposure range fixed at 10-15% per vintage. Source: Partners Group (2024), Burgiss. For illustrative purposes only.

Private Markets Mythbusters Series You can't control the cycles, but you can control your nerves | February 2024

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Keep control and choose your tactics

In a volatile economic environment like today's, we believe it pays off to keep control of one's nerves. By staying disciplined, investors can navigate market cycles effectively and take advantage of the opportunities arising from moments of dislocation.

Implementing a Constant Commitments strategy, however, is not an easy task. Simply investing in closed-end funds or funds of funds will not suffice, as in the end these funds will always retain control of deployment and inherently result in a more inflexible investment tool for clients.

To properly execute a Constant Commitments strategy, investors need the ability to access individual transactions ("direct" investments) across asset classes to ensure flexibility; an extensive investment platform that can generate robust investment flow to ensure diversification; and access to other instruments such as secondaries to take advantage of market cyclicality and add further diversification.

This can be achieved through a bespoke mandate solution, managed by specialist portfolio managers who have the necessary experience and tools to implement such a strategy.

As a more uncertain macro regime imposes itself, constant commitments and a flexible investment framework can make the difference between taking advantage of the opportunities created by market volatility, and watching them pass by.

Next time in our Private Markets Mythbusters Series

While applicable to any private markets investors, the ideas discussed in this paper are particularly relevant to those following an evergreen investment approach through open-end funds, which are inherently exposed to various market cycles.

As these structures rise in popularity, our next paper will take a closer look at their characteristics, with a view to equip investors with the tools to discern among the various offerings in the market and tackle the nascent misconception that all evergreen funds are created equal.

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Mythbusters Series.

The authors

Andrei Vaduva	Roman Smirnov	Anne-Marie Gruenig
Co-Head Portfolio	Head Mandates,	Portfolio
Management	Portfolio Management	Management

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Partners Group is a leading global private markets firm. Since 1996, the firm has invested USD 210 billion in private equity, private real estate, private debt and private infrastructure on behalf of its clients globally. Partners Group seeks to generate superior returns through capitalizing on thematic growth trends and transforming attractive businesses and assets into market leaders. The firm is a committed, responsible investor and aims to create sustainable returns with lasting, positive impact for all its stakeholders. With USD 147 billion in assets under management as of 31 December 2023, Partners Group provides an innovative range of bespoke client solutions to institutional investors, sovereign wealth funds, family offices and private individuals globally. The firm employs more than 1,900 diverse professionals across 20 offices worldwide and has regional headquarters in Baar-Zug, Switzerland; Denver, USA; and Singapore. It has been listed on the SIX Swiss Exchange since 2006 (symbol: PGHN). For more information, please visit www.partnersgroup.com or follow us on LinkedIn or X.

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