Five Reasons Private Assets May Offer Shelter from the Storm
Given the challenges in today’s market, private assets can offer a number of advantages—from an illiquidity premium, to diversification, to protection from rising rates and inflation.
1. Greater Diversification
While public markets have long comprised a wide range of asset classes, which has facilitated diversification, in private markets, the range of assets has continued to expand. For example, in private debt alone, three primary risk buckets have historically predominated: direct lending, real estate and infrastructure. But in recent years, opportunities have emerged in areas like consumer finance—including student loans, residential loans, and consumer loans. In addition, in the corporate arena, asset classes such as fleet financing investments are increasingly available. This growth has resulted in a much broader selection of asset classes available to private debt investors, potentially providing greater diversification and risk-mitigation benefits than in the past.
The diversification benefits offered by private markets are further enhanced by the way in which private assets are valued and priced. In public markets, asset values fluctuate daily and often in an exaggerated way, even in response to events that may have little impact on an issuer’s ability to repay its debt. With private assets, values tend to be more stable, although they do move in response to changes in interest rates or underlying credit fundamentals. The different manner in which private assets move relative to public assets provides a level of diversification beyond the different asset classes that are now available, and further contributes to private assets’ effectiveness in mitigating risk.
2. Potential Illiquidity Premium
Another attraction of private markets is the opportunity to earn a return premium over public market assets. This premium comes largely in exchange for giving up liquidity.
Historically, changes in this premium have been driven primarily by fluctuations in the public market rather than private market pricing, as some might expect. Private market investors and issuers tend to be longer-term in focus than public market investors, which gives them an ability to look through short periods of volatility. As a result, the coupons and spreads that private market investors demand—and that issuers are paying—tend to be more stable. As we saw in 2020–21, spreads in public markets widened dramatically, reducing the illiquidity premium offered by private assets. However, as public markets returned to normal, that premium was restored. Throughout that period, private assets remained relatively stable.