‘Chronic underinvestment’ threatens private markets providers

The experience of public markets can be viewed as a cautionary tale for private markets that growth may be strong currently, but the future could be less profitable and more operationally challenging, according to a consultancy. 

In the 10 years to September 2024, assets under management in private capital funds have increased over 160 per cent, dominated by inflows into real estate, infrastructure, and private equity funds.

But lessons from public markets – such as the introduction of rigorous governance, greater transparency, and accountability as they targeted retail and wholesale investors over the years – could also take place in the future for private markets. They are also well-supported by external service providers, technology, and systems to improve and maintain their operations.

The white paper from Mavin Advisory Group, titled ‘House of sticks: what private managers can learn from public market peers to strengthen their business’, recommended private markets managers undergo a strategic review, covering their existing operating and governance models.

While the sector may be experiencing tailwinds currently, the “chronic underinvestment” by providers in their operating practices could prove problematic in the future, especially for new entrants.

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“The experience from public market managers should not be ignored as they could signpost a more operationally challenging and less profitable future for private markets,” it said.

“Increased competition and internalisation will lead to inevitable margin pressure.

“A critical observation is that in their operations and technology functions these investment managers and service providers have remained immature. In fact, there’s a notable shortfall in leveraging this private markets era to invest in their own internal capabilities, outside of investments and business development, and secure their long-term sustainability.”

Another focus was the difference in public and private markets and their mindset, which has spun out of family offices, but will need to adjust as these firms find their funds being used by a retail audience.

“As many private market firms were spun out of family offices or large institutions, the mindset has traditionally focused on protecting the ‘house’ first and foremost. In building their funds management businesses, private market firms are strengthening their fiduciary focus which includes this operational and governance uplift,” it said.

Finally, the very nature of private markets and opaqueness must be balanced with the need to prevent revealing confidential terms or details of private negotiations.

Mavin said its improvements centred around five factors: independence, transparency, fairness, disclosure, and accountability.

This covered recommendations, such as separating investment and valuation committees, clear conflict of interest policies, clear valuation policies, fairness among different investor types, plain language disclosures, and clear investor information regarding higher fees and risks.

“Private market investment firms must move beyond short-term profits and prioritise building robust, scalable, and sustainable internal structures to secure their future in this increasingly competitive and more highly scrutinised landscape,” the report concluded.