Key Questions: Is Private Capital Still Earning Its Place?

Over the past two decades, private capital, including private equity, venture capital, and private credit, has seen significant investor demand. Strong historical returns attracted new investors, and existing investors steadily increased their allocations. As a result, managers raised more money to meet the demand.

That success changed the opportunity set. More capital now competes for private companies, loans, and assets. Purchase prices remain high in many areas; financing is more expensive; and investments are taking longer to realize. While investors could previously expect to earn a premium for locking up capital, the circumstances have changed. Illiquidity, by itself, no longer produces a premium return.

This does not mean investors should avoid or retreat from private capital. It does mean they should apply a more critical lens. Any potential investment should be assessed based on whether its return drivers are likely to persist in a more competitive environment characterized by higher financing costs.

The Hurdle Has Moved Higher

The broad case for private investing remains intact: Private markets can provide access to companies, assets, and sources of return that are difficult to replicate in public markets. But access alone does not make an investment attractive, particularly when it comes with higher fees and a longer holding period. There needs to be a more specific reason to invest.

Broadly speaking, we focus on three sources of potential advantage when evaluating private capital managers:

• Sourcing: Does the investment provide access to an asset or opportunity that is otherwise difficult to reach?
• Margin of safety: Is the entry valuation compelling?
• Value creation: Does the manager have both the plan and the capabilities to materially improve the business?
   

Ideally, an investment offers some combination of the three. If none is present, it is difficult to argue that the expected return justifies giving up liquidity.

The Opportunity Varies by Strategy

This distinction is especially important in traditional private equity. We are less convinced that broad exposure to buyout strategies will produce the return premium over public markets that investors have come to expect. Entry valuations remain elevated, financing costs have increased, and many of the tailwinds from the prior decade are unlikely to repeat.

Returns will need to come from earnings growth and operational improvement rather than leverage or a higher exit multiple (which is unknowable at the time of purchase). We still believe there are managers capable of creating value this way, particularly when they can buy into complexity at a reasonable valuation and do the hard operating work required to build a better company. The average outcome is likely to be less compelling.

The setup is different elsewhere. Venture capital has always produced highly concentrated outcomes, making diversification and manager access particularly important. Private credit can still offer attractive income, although underwriting discipline matters more as additional capital enters the market.

Secondaries require more distinction. Traditional LP-led transactions can provide diversification and the opportunity to acquire seasoned assets at an attractive price. On the other hand, we are less convinced by the growing market for GP-led secondaries and continuation vehicles, where alignment, pricing, and the ultimate source of return require closer scrutiny.

There is no single conclusion across private capital. The economics of the individual opportunity matter more than the label.

Selectivity Matters More Than Participation

The strongest case for private capital is not based on historical asset-class returns or the perceived exclusivity of an investment. It rests on a clear view of what will drive prospective returns, why the manager is positioned to capture them, and whether the expected reward is compelling relative to liquid alternatives after accounting for fees and risk.

These are basic questions, but they do not always have easy answers. That is appropriate. Giving up access to capital for an extended period should require a high degree of conviction.

Private capital can still play an important role in a diversified portfolio. We continue to find worthwhile opportunities where access is genuinely differentiated, valuations provide a margin of safety, or a manager can create value through operations or complexity.

We are less enthusiastic about committing simply to maintain an allocation or gain broad exposure to the asset class. There is too much capital competing for the same opportunities, and the cost of choosing poorly is high.

Private capital is no longer scarce. Compelling opportunities are.

For more information, please contact your advisor.