The public markets are relatively easy: there is transparency with analyst coverage of stocks, listed company financials are disclosed, trading prices, multiples and the various indices are right in front of you on the screen. You could buy into a stock on one single investment thesis, and then get out the very next day. If your thesis played out the way you anticipated and you got the timing right, then that stock investment could turn out to be extremely profitable for you. Sure, an institutional investor’s strategy would probably not be based on trying to time the market right, but timing is an important element of buying public equities because it is so efficient and liquid.
The private markets are a completely different ball game. An illiquid asset class that is as opaque as it gets. Valuations and information that are usually only available on a quarterly basis, and delivered to investors with a one-month lag at best. Closed-end funds that are 8, 10 or even 13 years in duration, longer than most economic cycles. To try to time commitments and “invest at the right time” just doesn't make sense. So when investors ask if they should be looking at Private Debt, Buyout, Infrastructure, Venture Capital, Distressed Debt or Special Situations strategies in this current market environment (article written in the summer of 2019), where we are clearly “late in the cycle”, the answer is a resounding yes, all of the above.
Window(s) of opportunity?
A market crash in the next two years could be devastating for Buyout and Private Debt, but a boon for Distressed Debt, so commitments to the latter would seem to make sense. However, if the late cycle becomes even much later or the correction turns out to be more like a soft landing, then the window of opportunity for Distressed Debt could be closed because fund investment periods to deploy capital is usually 3 to 4 years. The timing could be all wrong. The answer for such a situation? An investment strategy that can flexibly invest in both Distressed Debt and Special Situations, and capitalize on the right opportunities regardless of the market cycle.
In the context of Venture Capital, quite frequently there is talk about the “IPO window” and how it’s open, closed, or partially open; and then there’s the topic of valuations, overheating and Unicorns. All related to market environment and timing. Yes, these are all important factors. When it comes to the IPO window, that’s especially true for existing fund commitments where the underlying portfolio companies are ripe for exit harvesting, and when it comes to rising valuations, that is certainly relevant for funds actively investing in new deals. But such challenges, and how adequately they are overcome, depend on the fund manager, their investment acumen, experience, and skill set. To try to time investments, i.e. commitments to funds, or to base a decision to invest in Venture Capital on these factors is a moot point and the wrong approach.
Build your investment framework
Investing in the private markets is inherently a long term endeavor given the fund terms involved, so an institutional portfolio should be sufficiently diversified across strategies to deliver upside returns if markets are favorable, upside returns if markets are in a slump, downside protection in both market scenarios, and then steady liquidity across the board.
Using empirical evidence from a reliable, primary-sourced private markets database where the cash flow-based data is robust and accurate, investors can analyze and understand the differences between Small-cap, Middle-Market, Large and Mega Buyout strategies in terms of returns and risk parameters such as default rates, financing structure, debt ratios and pricing multiples. Likewise, a beta risk-adjusted alpha outperformance analysis can be performed on strategies such as Venture Capital to measure the alpha boost that can be achieved from an early stage Healthcare / Life Sciences strategy vis-a-vis a later stage TMT strategy. And then there’s liquidity: how different are the liquidity characteristics between Senior and Mezzanine debt, if any, and also when compared to Infrastructure? By quantifying the risk, return and liquidity characteristics of the various investment strategies and sub-strategies, an investment framework can be designed which is optimized for each of these parameters and for favorable, benign and challenging market conditions.
Timing the market is not a strategy
Back to our original question above, as to whether timing the PE market makes sense: No it doesn't. While trying to select the right time to invest in a private markets strategy doesn’t make sense, selecting the right fund managers to deploy the strategy always makes sense. The one vital component of the selection process is due diligence. Analyzing a GP’s track record by fund vintage years and portfolio company investment years allow LPs to evaluate returns and risk across cycles, such as financing structure and deal pricing development over time. This enables LPs to understand GP investment and exit behavior across different market situations, which ultimately leads investors to investment decisions based on actual empirical evidence.
For LPs investing in private markets funds, timing the market is not a strategy. Investing in the private markets requires a pragmatic and systematic approach, based on sophisticated analytics powered by innovation and verified primary-sourced cash flow private markets data.
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