Advisers assess red flags in private market funds

Two financial advisers have shared why private markets may be the hot topic of the day, but advisers shouldn’t invest if it doesn’t fit with their clients’ needs. 

Private markets have become a popular investment in recent months, especially private credit, as firms make a push at targeting retail or wholesale clients beyond their traditional institutional focus.

But it has also brought about concerns from research houses that have highlighted the performance dispersion between the best and worst managers and the illiquidity profile of the asset class.

SQM Research has put the sector “on watch”, while Lonsec’s chief investment officer, Nathan Lim, has described manager selection as a “critical risk” when choosing private markets funds due to the number which have limited track record.

“I’d really be calling out manager selection as another critical risk when considering private assets because the dispersion in returns between the highest and lowest quartile managers is much wider than in public markets,” he explained.

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For financial advisers, it may be tempting to chase the higher returns offered by these funds, but potential red flags mean they may not suit every investor. 

Speaking to Money Management, financial adviser Andrew Saikal-Skea said he has explored the funds for a number of years but never found one where he is comfortable to invest. 

“I can see it is very tempting for advisers as they promise high returns, so it is understandable they get drawn in. But I look at it from the perspective of wanting to feel comfortable and not lose my client’s money.

“There are so many funds out there, and it’s hard to have confidence that the one you pick isn’t going to end up being problematic. I keep abreast of it and consider the options. I can see the advantages, but I haven’t found anything I like. For me, the balance is tilted towards making sure my clients don’t lose money.”

Appearing on an Ensombl podcast, Kieran Berry, chief executive and managing director at wealth manager River X, said he is careful to maintain only a small allocation.

“When we are looking at private credit funds, no fund can represent more than 5 per cent of a portfolio regardless of the diversification of the underlying fund. We do that for diversification and risk mitigation against a single manager going under.”

A key factor that Berry said he considers when choosing a fund is the threat of related party interest that involves conflict of interest. If due diligence of a fund indicates this could be an issue, Berry said that would be a red flag for him as an adviser. 

Berry said: “The one thing where we are really worried is anything with related party risk in illiquid assets. If we get a sniff that there’s a lot of concentration risk in a portfolio or related party interest, then that is a conflict and we will back away from those opportunities. 

“If it feels like there’s a conflict, there’s enough choice in the market for us to go elsewhere.”

Related party interest was also flagged by SQM Research head Louis Christopher, who said it is important to drill down into management to ensure there is no related party risk. 

“We want to know who they are so we can rule out that they are not a related party. This is important because we have been seeing certain instances where there’s been related party lending. As a research house, we are not comfortable with that,” he said on a separate Ensombl podcast. 

Nevertheless, Berry maintained the assets do have a role and can be a way for an adviser to add value.

“I’m looking at how I can make portfolios more bespoke and offer a personalised approach. As an adviser, if I’m pitching an HNW family and can bring them a bespoke solution, that can be the difference in winning that client.”

For Saikal-Skea, red flags for him on a fund would be differences in the net asset value (NAV) and managers who have previously closed other private markets funds, especially if they are unclear on the reason behind that.

“I look at the NAV and whether it is different to the trading price. Does this mean it has a strong value but the brand is damaged or the market is worried about something? You can never really know the true valuation of the assets in the fund. They can also devalue and not in a way that returns again.

“I would also be careful if the manager has closed funds previously and moved the assets into a new fund. We’ve seen that happen and it makes me uneasy.”

However, while he is nervous about going into the asset himself, he has had clients come to him with existing exposure to the asset which has presented the problem of whether it should be retained.

“People do come to us who are already holding private market exposure; one person had 80 per cent in private markets and most of that isn’t liquid, so we engage with them as to whether it should stay in the portfolio.

“Sometimes they didn’t really understand the risk they were taking or what they were investing in at the time or maybe the risk was downplayed to them.

“A lot of funds will have redemption events periodically, so we find clients – usually high-net-worth ones who are happy to accept a level of risk – will be comfortable exiting steadily over a period of time rather than making a rash decision to exit all at once. We try to bring the allocations back to a reasonable level.”

For him, he said, choosing the investments for a portfolio was only one part of being an adviser, and he felt there were multiple ways he could add value to his clients beyond the financial returns achieved.