(Bloomberg) – The private market is coming to rally – and it threatens to wreak havoc on global stocks and bonds.
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As financial conditions tighten around the world, private markets funds are demanding that investors put up more of the money they pledged in the easy money days during the pandemic.
While many large pension and endowment funds are expected to have sufficient cash flows to meet these capital calls, there are concerns that a large number of other investors will need to cash out to meet commitments. That would likely mean even bigger losses in the public equity and bond markets, where yields are already down more than 20% this year.
According to data from Burgiss Group LLC, early signs of trouble are showing in the shrinking payouts these private markets partnerships are delivering to investors.
Five of the six private markets fund categories tracked by the research firm had negative net commitments in the third quarter, meaning investors had to put more money into them than the returns came back. Buyout funds posted the widest gap at minus $7.66 billion, the widest since the second quarter of 2020, the data shows.
“We see cause for concern,” Burgiss analysts Patrick Warren and Luis O’Shea wrote in a note last month. “Net payouts from venture capital are now at multi-decade lows, and senior and distressed debt are also making net calls.”
Three of the fund types have returned the smallest amounts of money to investors in at least seven years.
Capital calls have accelerated this year, particularly for private debt funds, said an executive at an institutional investor that manages more than $50 billion. Portfolios known as trigger funds, which request client capital once certain thresholds are met, have been among the most active capital calls, the executive said, asking for anonymity to discuss internal matters.
The story goes on
“One can imagine large institutions forcing sales of liquid public stocks to meet capital requirements in private fund investments,” wrote Benn Eifert, founder and chief investment officer of boutique volatility hedge fund QVR Advisors, in his October letter to investors.
Capital calls are not the only problem for investors in private markets. Even their successes are a headache.
As many alternative investments have outperformed public markets in recent years, institutions have exceeded set limits on the proportion of their portfolios that can be allocated to private markets.
While this so-called denominator effect may be overblown – because there is a lag in repricing private assets to reflect the very latest market conditions – it has the potential to trigger increased selling at a time when it is least desirable.
And the sums could be enormous. A significant chunk of the easy money pumped into the financial system by central banks during the pandemic found its way into unlisted assets, which grew to $10 trillion globally by September 2021, a five-fold increase, according to figures from investment data firm Preqin compared to 2007.
“There is a kind of regime change in the macro world and in the markets that we need to get a handle on,” said Stephen Klar, President and Managing Partner of Wellington Management Co 3. “We work with our clients to think about how we really diversify and balance that asset allocation again.”
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