How asset managers can safely ride the private markets wave

Key Takeaways

• Booming private markets provide new avenues of growth
• Compliance and operational complexity are challenges
• Technology, data tools can help asset managers succeed

Over the past decade, the investment landscape has undergone a remarkable transformation, with private markets emerging as one of the most influential forces shaping asset management. As traditional instruments like bonds and equities buckle under the weight of volatile markets and diminishing returns, private markets have risen as an enticing alternative.

According to KPMG, private asset management is on the rise as investors seek higher returns and diversification in a low-yield environment. However, compliance, operational complexity, and the integration of Environmental, Social, and Governance (ESG) factors are challenges.

Let’s take a look at what is driving the expansion of private markets and how asset managers can overcome the hurdles.

Appeal of private markets: A quest for higher returns

In the past few years, private asset management has witnessed exponential growth. Global private market assets under management (AUM) exceeded USD 13 trillion in 2023, according to the McKinsey Global Private Markets Review 2024, reflecting an annual growth rate of approximately 20% since 2018.

Private markets offer a broad range of investment opportunities in private equity, private debt, real estate, and infrastructure. The study outlined how a growing number of asset managers are moving into private markets for alternative investments. The shift is driven by multiple factors, including higher returns.

Bain & Company said that asset managers should increase their investments in private markets due to increasing competition in the industry and the need to diversify portfolios, given the volatility in public markets.

Drivers of private markets

• Strong overall performance: The report by McKinsey highlighted that private markets outgrew public by a margin of over 10%-12% in recent years. Factors contributing to this include private investments offering higher returns, lower susceptibility to public market volatility, and the increased flexibility in investment strategies.
• Low returns in public markets: Traditional market income and price appreciation opportunities are declining sharply due to extreme competition and increased volatility. Public markets are often subject to rapid and unpredictable price swings driven by global economic factors, geopolitical events, and market sentiment. Such factors push investors to explore other avenues offering better risk-adjusted returns.
• More opportunities: As more and more high net-worth individuals shift towards private markets, opportunities are booming. The expansion of private markets is also driven by their unique ability to offer more tailored investment solutions, a feature that sets them apart from public markets. This influx of capital into private markets has created a virtuous cycle, where increased investment leads to more opportunities.
• Access to more capital: The growth in private markets is increasing the diversity of investors, leading to further influxes of capital. The McKinsey report mentioned that beyond traditional institutional investors such as pension funds and insurance companies, new sources like family offices and sovereign wealth funds have emerged. With this surge of capital, private markets have expanded their reach, supporting the growth of new industries and innovations.
• Long-term horizon: Unlike public markets, private markets are not obsessed with quarterly earnings reports or market sentiments. Investors in private markets concentrate on long-term value creation, which widens the scope of more strategic decision-making. According to the Bain & Company report, the trend is particularly advantageous in emerging sectors like renewable energy or biotechnology.

Hidden costs: Operational complexity and compliance

While private markets are growing, they have several operational complexities. Asset management firms need to distinguish between private and public investments, which is a complicated process requiring distinct teams, processes, and systems. This is reflected in increasing operational costs.

The KPMG report highlights that regulatory pressures also add to the burden, necessitating sophisticated risk management strategies and advanced compliance frameworks.

Obtaining reliable ESG data for private companies is significantly more difficult than for publicly traded firms, making integration difficult. In public markets, companies are mandated to disclose details like environmental impact, labor practices, and governance structures when filing with market regulators. With no such compulsion in private markets, the job of asset managers becomes a complex and resource-intensive task.

Such technicalities are exacerbated in the European Union where the Sustainable Finance Disclosure Regulation (SFDR) requires asset managers to disclose how they integrate ESG risks into their investment decisions.

Leveraging technology: AI and ESG integration

Asset managers already use AI tools for various tasks like predictive modelling, market trend analysis, and risk management. According to the Index Industry Association’s 2024 survey, asset managers view AI as a critical tool for optimizing portfolios and improving investment performance.

The need for standardized ESG data for private companies can pose a big challenge for asset managers. An article in the Global Banking & Finance Review said that AI can help analyze unstructured data, providing insights into private firms’ ESG performance. However, optimum caution must be exercised when using AI technology, as the risks associated with data privacy and cybersecurity are significant.

Balancing opportunities and risks

It is crucial to strike a balance between the increasing opportunities and risks in private markets. The Bain & Company article underscored the importance of agility and adaptability in managing these risks. Asset managers must build comprehensive strategies to withstand market volatility and regulatory changes. They must also develop a deep understanding of the sectors and look for ways to improve the compliance dynamics of private companies.

The expansion of private markets represents a significant evolution of the asset management industry with promising returns and diversification. However, success in private markets requires investment and the capability needed to manage private assets effectively.

In today’s complex regulatory environment, staying compliant is more challenging than ever. Relying on outdated systems, manual processes, and spreadsheets makes it difficult to keep up with constantly changing regulations and to provide the clarity that regulators and clients expect. To be a winning position, asset managers must ensure they have complete asset-class support, worldwide regulatory coverage, the ability to centralize and maximize data across their business, and high-performance cloud-based technology with maximum security built-in.