A portion of the superior risk-adjusted returns shown in Figure 2 may be due to the lower “failure rates” among late-stage companies. While early-stage VC companies may be pioneers of new industries with evolving business models, late-stage companies may have established business models and greater traction in the marketplace, potentially resulting in lower failure rates. This risk profile may be a better fit with a corporate plan’s investment objectives, which are often focused on managing funded-ratio volatility and drawdowns.
Of course, none of this is to say that the late-stage market is without risks of its own. For example, a market retrenchment or a shift to a “risk-off” environment with respect to equity investments or capital spending may cause these companies to experience a delay in liquidity events. A recessionary environment would also be challenging because we could see a confluence of poor fundamentals and a weak IPO market. Additionally, manager access and selection are key determinants of investment success in private markets. There is significant dispersion between top- and bottom-quartile private managers relative to the public universe. Selection and discipline are especially important in today’s environment, where manager activity is high and the exit environment strong.
What about private credit?
Private credit strategies may also play a role in a plan’s return-seeking allocation, with investors in this asset class typically seeking equity-like returns with lower volatility and shorter lockups (6 – 8 years, for example) than traditional private equity. Private credit may also offer higher income relative to public credit, motivating some plans to consider holding allocations within their liability-hedging allocation.
Before implementing a private credit allocation, we think plans should determine their specific objectives, given the diverse range of strategies across the liquidity and risk spectrum. These include strategies focused on senior mortgage loans and senior unrated direct lending strategies, which often form the core of a private credit approach, as well as venture lending, distressed debt, CLO equity, and other niche sectors approaching more “equity-like” risk.
In summary, a thoughtful approach to liquidity management, starting with the end state in mind and working backwards, may provide plans with the flexibility to invest in targeted private market strategies in the pursuit of their return objectives.