Allocators Think PE Will Offer the Best Returns — Despite Valuation Controversy

“Those years that follow the downturn tend to be great years for investing in private capital,” says Commonfund’s Mark Anson.

Illustration by II

Illustration by II

The ongoing debate over valuations hasn’t disrupted institutional investors’ confidence in private equity.

Seventy percent of institutional investors believe private equity will provide the highest absolute returns of all assets over the next 12 months, according to Commonfund’s annual market sentiment survey that is expected to be published on Wednesday. About half of the investors who were surveyed expected the highest returns to come from private real assets and private credit over the next year.

“As people look in the rear mirror and they saw private equity not being marked down as fast as public markets, they look at that as a natural buffer,” Mark Anson, CEO and chief investment officer of Commonfund, told Institutional Investor in an interview. But he thinks investors are right to believe that private funds will outperform. A previous Commonfund study has shown that private equity funds have an average illiquidity premium of 3.5 percentage points, even after taking into account the valuation lag, he added. The premium is what investors earn over stocks, which can be sold at any time.

“Those years that follow that downturn tend to be great years for investing in private capital,” Anson said. “Why? Because valuations come down, companies become cash strapped and are looking for other sources of capital to help them get through that period.” He added that allocators who are experiencing the denominator effect – meaning those who are overweight private equity as their public portfolios shrink – should still try to keep investing in PE because 2023 could end up being a great vintage year.

Private market valuations have become the center of debate as investors’ public portfolios have suffered huge losses amid persistent inflation and surging interest rates. Because private equity funds aren’t marked to market on every trading day, they have appeared to be less volatile — with higher valuations — than their public market counterparts. But whether private equity funds can continue to outperform public markets over the long term remains an ongoing debate.

Investors’ interest in private credit surged more than 20 percentage points in the past year. Last year, Commonfund found that only 19 percent of institutional investors thought private credit could deliver the best absolute returns. About 200 institutional investors that manage a total of about $849 billion in assets participated in this year’s survey, which was conducted in mid-February.

Banks have stepped back from lending since 2008 and 2009, when regulators enacted rules to prevent a repeat of the financial crisis, Anson said. “[Private credit funds] are stepping in to fill the gap that used to be filled by banks,” he said.