Introduction:

In the face of increasingly unpredictable and uncontrollable economic and market developments, LPs need to concentrate their efforts on aspects they can directly influence. Within private markets portfolios, LPs can have the greatest impact by focusing on four actionable areas.

Mitigate Capital Call Variability through Diversification:

Diversification in private markets not only offers potential performance benefits but also helps manage capital call volatility. While each fund may deviate from average pacing, a portfolio of diversified funds can potentially offset random deviations to a certain extent. PitchBook data suggests that LPs investing in a single buyout fund for a specific period may experience an 8% standard deviation of quarterly contributions. In other words, in two-thirds of cases, the actual amount called in a quarter could fall within a range of 16% (8% above to 8% below the average amount). However, by allocating capital across 10 funds instead of one, investors can reduce that range by half to enhance predictability. It is important to consider available resources, such as staff and funds, to effectively manage the administrative burden and the limited availability of high-quality GPs and funds when determining the number of funds to include in the portfolio.

Reevaluate Approaches to Managing Undrawn Commitments:

LPs should reassess their approach to managing undrawn commitments. Some LPs maintain highly liquid instruments or cash reserves equivalent to several months' worth of anticipated net capital calls, while allocating the remaining amount to assets that align with the risk/return profile of their private markets portfolio. While this approach may not require drastic changes, LPs could consider adjusting the magnitude of cash flows associated with anticipated capital calls or the number of months of capital held in reserve. LPs employing a more dynamic cash management approach, examining anticipated calls on a monthly or quarterly basis, may need to make more significant adjustments to maintain liquidity and optimize deployment of capital. Where the majority of funds invested by an LP utilise significant Subscription Line facilities, LPs can look to ease the cash reserves set aside for unexpected capital calls and invest that money for higher return as capital calls will be more regular and can be planned for.

Recognize the Benefits of Secondary Market Sales:

LPs are increasingly utilizing the secondary market to manage allocations, cash flows, and to create capacity for new investments. Options range from selling full or partial fund positions to structured and preferred equity transactions that provide cash in the short term while retaining future upside potential. The appropriate approach depends on the LP's specific objectives, including pricing, liquidity requirements, and NAV management. It is important to note that not all assets are equally attractive to secondary buyers, and these processes often require GP approval. LPs should consider the time required and the potential impact on resources when evaluating secondary market options. Engaging with reputable secondary market participants and seeking expert advice can help navigate the complexities of these transactions effectively.

Recalibrate Long-Term Commitment Strategy:

The current environment presents an opportunity for LPs to reassess and potentially adjust their long-term commitment strategy. With global equities and investment-grade bonds experiencing declines, return expectations for the next decade are expected to be lower. This shift may impact the overall trajectory of portfolio assets, necessitating adjustments to the pacing of private markets commitments to maintain allocation within policy ranges. LPs should consider implementing more sophisticated forecasting methods that provide better insights in an increasingly uncertain market environment. However, making drastic changes in the near term should be avoided, as market timing has shown limited benefits in the long run and can impact relationships with preferred GPs and the LP's investment team. Periodic recalibration of longer-term targets and commitments based on the evolution of the overall portfolio value is a prudent approach that ensures alignment with investment objectives and risk tolerance.

Conclusion:

LPs can take proactive steps to effectively manage their private markets portfolios amid the evolving market landscape. By focusing on diversification, reassessing approaches to undrawn commitments, leveraging the benefits of secondary market sales, and recalibrating long-term commitment strategies, LPs can navigate the challenges posed by unpredictable economic and market developments. These actions allow LPs to exert greater control over the aspects that directly affect their portfolios, ultimately leading to more effective management of private market investments. LPs should continuously monitor market conditions, stay informed about industry trends, and seek expert advice to make informed decisions that align with their long-term goals and risk appetite.

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