Growing Private Equity Exposure of Limited Partners
March 5, 2019
March 5, 2019
As limited partners (LPs) start gearing up for new commitments in 2019, we’ve noticed that LPs are growing their private equity exposure. Specifically among insurance companies, LPs are looking to the private markets for consistent returns and outperformance relative to the public markets.
Growing Private Markets
Hamilton Lane’s 2018 Market Overview highlights the increasing growth of the overall private markets. Furthermore, the industry continues to grow and mature as seen through the growing total exposure and proliferation of fund variety.
As you can see in the graphic above, the growth of all private markets has almost tripled.
Clearly, the proliferation of private markets variety is increasing the opportunity set for LPs. However, the increasing number of choices means that there is an added degree of complexity to the fund diligence and monitoring processes. As a result, we’ve seen more LPs, particularly insurance companies, turning to technology solutions to help them understand the private markets industry and plan for future commitments.
Private Equity Outperformance
The private markets can be expensive and a hassle to invest in. So why do investors do it? Because, historically, the private markets have outperformed the public markets. Since private equity is typically thought of as a long-term investment, let’s take a look at the historical performance of each asset class over the past 20 years.
Over a 20-year period, private equity outperformed public benchmarks. If we take a further look, private equity even outperformed hedge funds, often considered an asset class comparable to private equity. Even more, private credit and real assets investments were able to outperform their public benchmarks over a 20-year period.
Growing Private Equity Exposure Using PME
We’ve already talked about how the private markets are growing and shown how they are outperforming. But, how do we show this to an investment committee or board of directors?
A public markets equivalent (PME) is one way to demonstrate this asset class’ outperformance over the public markets. PME is a benchmarking methodology used to compare private markets investments against a public index. In other words, PME helps evaluate the opportunity cost of foregoing an investment in publicly traded instruments in order to make an investment in a private markets portfolio.
For reference, PME is calculated by simulating an investment in a specified public markets index. This is done by investing in or withdrawing capital from the index on the same date a contribution or distribution is made in the private equity fund.
As shown below, the private markets are outperforming the public markets, using the MSCI World Index as a proxy, in nearly all vintage years!
Source: Hamilton Lane Data via Cobalt LP, Bloomberg (November 2018). 3, 4
Clearly, the PME benchmark is a calculation-intensive exercise. Fortunately, technology solutions, like Cobalt LP, simplify the process for LPs, allowing them to run the calculation at the click of a button. Additionally, Cobalt LP allows users to choose a PME methodology and index to allow for custom analysis. Furthermore, users can view industry-level PME, portfolio-level PME and fund-level PME.
As the private markets are growing, investors are taking note and starting to increase their allocations to private equity. The subsequent historical outperformance also makes this an easier conversation to have with an investment committee or board of directors. Moreover, PME benchmarking methodology is an effective way to show your investment committee or board of directors the private markets outperformance against the public markets. Furthermore, LPs can use PME on their own investments to highlight how their funds and portfolio are performing against the public markets. To make PME more approachable to LPs, consider using Cobalt LP or another technology solution internally.
For more information about PME or Cobalt LP, please reach out to us here.