From multiple keynote speakers to individual sessions to informal conversations to research and product announcements, one topic dominated the zeitgeist at the Morningstar Investment Conference last week in Chicago: the convergence of public and private markets and the race to bring access to wealth investors.
At the conference, both alternative asset managers, like Blackstone, and traditional asset managers making headway into private markets, like Vanguard and BlackRock, addressed the topic. In addition, Apollo Global Management CEO Marc Rowan sat down with Morningstar CEO Kunal Kapoor for one keynote session.
Many of the same beats came up again and again: The dearth of publicly listed companies is driving interest in private equity. The restructuring of capital markets post-Great Financial Crisis has fueled the explosion of private credit. Governments are increasingly using public/private partnerships to fund infrastructure projects.
On the product side, the rise of evergreen structures has brought private investments down market. Asset managers have also continued experimentation in packaging private investments (ETFs, target date funds, model portfolios, SMAs), which must be sorted in the coming months and years to discover what investors prefer.
In short, there’s consensus on growing interest and access, but there is uncertainty about where the private wealth channel will land regarding how best to incorporate private assets into portfolios.
“It’s going to be a while before private market investments have the impact of public … but it’s dominating conversations, headlines and maybe your LinkedIn feed,” Morningstar CEO Kunal Kapoor said during his remarks to the conference. “Public investments will remain the trusted path. … If you’re going to change anything, you need to be sure you’re adding incremental value, not subtracting.”
Dana Emery, chair and CEO of Dodge & Cox, however, raised some concerns about the space’s rapid development and warned attendees to take their time.
“When we go out to clients, they feel overwhelmed by the number they are getting marketed on—and the number will only rise,” Emery said. “For me, there are alarm bells having done credit for a lot of my career in looking at the sheer amount of money chasing this area, including some managers that don’t have experience … and have not been through a credit cycle.”
Emery cautioned advisors to be serious about due diligence in gauging managers and vehicles and evaluating whether investors are being paid the right price for giving up liquidity.
“I think a lot of the illiquidity premium has been driven out,” she said. “So, are all the tradeoffs worth it?”
During his keynote, Apollo’s Rowan tried to allay some of those concerns. He also argued that alternative asset managers are only targeting individual wealth today because institutional capital is now tapped out.
“We are not short capital. We are short origination,” Rowan said.
He said firms like Apollo, which used to primarily source capital from institutions, now work with HNW individuals, accredited investors, retirement plans and partnerships with traditional managers. Their ability to originate deals has not grown at the same scale.
“If we originate good risk, we’re on allocation,” he said. “It’s a question of who we serve, not whether we can do it. … We think we’re going to be balanced on the demand side as long as we meet our promise.”
Rowan added that he believed the 60/40 allocation model would evolve to where one-third of each equities and fixed-income allocations would become private markets.
“It’s already happening in managed accounts, retirement, insurance, and it’s starting to happen more broadly in asset management,” he said.
As for Morningstar itself, the firm published an overarching report on the state of semiliquid funds (in advance of its planned unveiling of medalist ratings for those funds later this year) and debuted new features in its Direct Advisory Suite product aimed at helping advisors evaluate, compare and communicate the role of private investments within client portfolios.
The report found $350 billion in net assets between non-traded REITs, non-traded BDCs, interval funds and tender offer funds. However, interval funds account for a disproportionate percentage of new fund launches.
Notably, Morningstar examined the opaque fee structure on many of these semi-liquid vehicles, cautioning advisors and investors to understand the premium they are paying when deciding whether to use the funds.
“These are significantly more expensive than mutual funds and ETFs. There are a lot more fees in them, and we don’t think they are well explained to investors,” said Jack Shannon, a principal, equity strategies, for Morningstar and one of the report’s authors.
Morningstar cited an example in the report of an interval fund with 16.62% in returns through interest, dividends and gains, where the net return drops to 9.75% due to a combination of debt costs and management, incentive and other fees.
Further, the report pointed out that semi-liquid fund managers have set incentive fees and hurdle rates at very low levels, making them inconsequentially easy for managers to meet, unlike how incentive fees are designed in more traditional private funds.
“An incentive fee on capital gains is standard part of the private equity industry. But in those cases, it’s well aligned,” said Brian Moriarty, a principal, fixed-income strategies at Morningstar, and another of the report’s authors. “With semiliquid funds, they are setting the hurdle rate and … they are picking the rate they lend at. They are picking a lending rate above the hurdle rate. So there’s never a scenario where they would not earn the hurdle.”
The report also noted that semi-liquid fund managers charge fees on total assets rather than the more standard practice of fees based on net asset value. Thus, it isn’t easy to compare them to other funds.
On the product side, Morningstar’s Direct Advisory Suite enhancements include a new private capital fund comparison screen, an updated categorization system that includes private market vehicles, additions to the Morningstar Risk Model to account for private market funds, tools to visualize what percent of client portfolios are exposed to private investments, and other features.
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