Finding the picks that deliver superior performance in the private markets is tricky.
There’s an absolute tyranny of choice in alternatives, with half a million private companies. Compare that to a shrinking public market with about 4,000 companies listed on public exchanges. The gap has been widening, with the number of public companies dropping by more than half since the late 1990s. Today, we see more companies staying private longer and sometimes never making it to an IPO but exiting through mergers and acquisitions.
All that choice means you can get a wide range of outcomes from private market funds compared to funds limited to the public market, where even the poorest performers may be a percentage point or two below the best funds. Top-quartile private market funds return a net IRR above 19%, while the bottom funds underperform the public markets, with a net IRR of around 3%.
This makes manager and fund selection critical to the success of an investment. It’s not just about investing in alternatives, but high-quality alternatives. A poor choice here can be costly, with some bottom-quartile funds underperforming similar investments in public markets.
Identify Managers with Potential
You need to identify the right partners and take a long-term view to be successful in private markets. The right manager will generate returns across market cycles. Finding these individuals requires building a proper vetting and selection framework. You must understand the team dynamics and investment process and dig into how a team maximizes returns through portfolio management.
Resources to Conduct Due Diligence
It takes time to build an alternative strategy comprising numerous asset classes across vintage years. You need industry experts to help you go more profound than the investment prospectus. You need to invest in technology and databases such as Preqin to help track managers, understand vintage years, and see who the top managers are year in and year out.
Track record is essential, but it’s important to understand the actual alpha generated by the team instead of what’s just from the market. Many factors are at play, including strategy, team, talent, sourcing, etc. Try to look through the funds to the portfolio company level to understand the sector and geographic exposures. It’s not science, and it’s not art – it’s a combination of the two.
Understanding Fee Structures
Fees are necessary, but it’s more around how they’re structured than the absolute amount. Ask yourself these key questions:
- Does carry align the interests of the team, the GP, and the LP?
- Are all the different team members properly incentivized to create long-term value?
Many focus on the percentage the GP contributes to the fund. Still, it’s essential to look at that from the GP’s perspective and see whether it’s a meaningful amount for them, given their financial situation. This naturally won’t be the same for a veteran established manager who has earnings from previous funds as it will be for an emerging manager striking out on his own.
Building an alternative strategy takes time. You need the patience to invest a lot of effort in finding the right partners for you and then correctly monitor your program. Building that infrastructure and technology to identify outstanding fund managers while maintaining oversight of performance and things like cash flow and capital calls is challenging.
This is where Gridline comes in. Our investment process and platform help you quickly discover managers that will outperform while making performance reporting and treasury management as easy as checking your stock portfolio. Our products let you tap into the resources you need to quickly and efficiently build a diversified portfolio of alternative assets without spending years building relationships and learning from failed investments.