High-net-worth investors, who control about $86 trillion in assets, represent a significant opportunity for private markets, according to officials from private equity firm Hamilton Lane.

Such investors represent an alternative to the institutional investors that general partners look toward to raise more capital, said Steve Brennan, head of private wealth solutions at Hamilton Lane during a virtual roundtable yesterday discussing the firm's 2023 Market Outlook report.

“Those institutional investors today are largely tapped out and not able to support the desire for expansion by the general partners,” he said.

That means general partners have to turn to the relatively untapped market of the high-net-worth investor, he said. And any contribution by these investors could represent a significant shift in the size of the private markets, according to Brennan. There is currently about $7 trillion in the private markets.

“If you just have a 1% shift in high-net-worth assets into the private markets, it would increase the size of the private markets NAV overall by more than 10%,” Brennan said. “It is a massive opportunity and potential source of capital for the private markets.”

To capture this market, general partners will need to adapt and provide certain things to make private markets accessible to high-net worth investors, he said. High-net-worth investors are looking for ease of use, options for liquidity, immediate deployment of capital, and access to leading managers, Brennan explained.

Those qualities have been fueling the semi-liquid fund or registered fund markets. The funds include non-traded real estate investment trusts (REITs), non-traded business development companies (BDCs), interval funds, and tender offer funds. The registered funds have seen a 100% increase in their assets under management in the past three years, Brennan said.

Traditionally they have been focused on real estate and private credit strategies. However, the firm expects private equity offerings to also increase going forward.

Private markets continue to outpace the public markets, even as the public markets struggle in the current volatile market. During the roundtable, the Conshohocken, Pa.-based firm showed the value of $1 invested in various markets. For private equity, it would be worth $2.24 while public equities would be worth $1.23.

“Private equity tends to really outperform when the public markets are generating … poor to average returns,” Brennan said. “As the public markets are generating good to great returns, private equity still outperforms, but that level of outperformance is not nearly as significant.”

He went on to explain that poor to average returns involve those ranges from less than –5% to 10% and the range for good to great returns was as least 10% to more than 15%.

The firm expects the positive returns for private markets to continue as the public sector is going through what Brennan described as a time of poor to average returns. Generally, private markets outperform public markets when the latter is doing well. The private funds significantly outperform the public sector during a down economy, according to Drew Schardt, head of global investment strategy at Hamilton Lane. 

“It doesn’t mean that returns in public or private markets won’t come down, but we’re saying that a relative outperformance tends to be better for private market strategies in times like this,” he said.

However, private markets do not act independently of the public markets. What happens to one will impact the other, the degree in which that happens will depend on certain circumstances, Schardt told the audience. 

“The two asset classes – public and private – are correlated,” he said. “Typically, when one goes up the other will go up, when one goes down, the other will go down but generally speaking there is less volatility.”

The reason private funds are more resilient to the ebbs and flows of the market have to do with several factors and one of them is their governance model, Schardt said. 

When a person makes an investment into a public fund, while they have invested their money in those options, they do not have control over how the business is run. That is not the case with a private investment. 

In a private fund, the investor controls the board and has a say over the strategic operational initiatives of the business. They are also not forced to buy or sell anything in a public investment. That means a private investor can focus on creating value over a three-to-five-year period, which will help insulate the business during turbulent times, Schardt explained. 

“If you’re going to hold something for that long of a period, you’re generally putting in a debt and capital structure that’s going to be resilient and going to have wherewithal,” he said. “You are also able to control and steer the operating performance of the business more so than you can when you invest in a very efficient public market.” 

As public funds began to drop, many expected that the private markets would follow suit. That did not happen to the same extent, meaning that private funds continue to be a profitable investment. The firm anticipates that will continue to be the case for the near future, according to Schardt. 

“Everyone seems to be waiting for this other shoe to drop regarding private market valuations, it’s not going to come,” he said. “It doesn’t mean private market valuations can’t come down or won’t come down they may … but it won’t be because the number are fictitious, you see the correlation and alignment with the movement on the public side.”