As alternative asset investing continues to grow, the investor base is inevitably broadening out as fund providers innovate to meet a more diversified set of investor needs.
In particular, the wealth management segment is fast emerging as a key private markets growth area. McKinsey projects that private markets allocations will comprise 3-5% of U.S. wealth management assets in 2025, growing $500 billion to $1.3 trillion in assets.
Asset managers such as Morgan Stanley Investment Management are responding to these needs by democratizing access and taking a range of private asset classes and making them available to a wider investor audience. Often called semi-liquid funds, these structures offer several advantages for individual investors, which we explore in this piece.
Operational simplification
Avoiding the demands of periodic capital calls appeals to intermediaries and end investors alike. In semi-liquid structures, capital is committed and called once, typically monthly or quarterly, after which time investors can opt to make additional subscriptions. For many investors, the ability to make a one-time commitment, as they would in traditional funds, is valuable. For intermediaries and wealth managers, semi-liquid funds are less resource intensive; operational teams monitor and communicate upcoming capital calls or past calls that an investor may have delayed or missed on a monthly or quarterly basis.
Semi-liquid funds require the fund manager to actively manage a “liquidity sleeve,” which are the liquid assets the fund must maintain to manage cash flows. Additionally, with upfront investments in semi-liquid funds, the fund manager must fully deploy the capital. Managers who are unable to invest quickly into private markets may have to invest elsewhere, such as highly liquid asset classes. As a result of these two dynamics, the capital in the “liquidity sleeve” may be in the form of cash or invested in liquid public market investments to minimize the cash drag. Investors evaluating semi-liquid funds should weigh the benefits of exposure to private assets against the potential cash drag or the potential for the fund to be more correlated to traditional markets that comes with some measure of liquidity. The liquidity sleeve may affect the overall return, depending on how it performs in comparison to the private asset targeted.
Valuation
Confidence in accurate valuations for both incoming and exiting investors is essential in semi-liquid structures. This confidence can be achieved through the proper valuation procedures. Investors should test the procedures during the due diligence process and select only those strategies that display a consistent ability to price investments in a fair manner for all investors.
Semi-liquid structures facilitate choice in redemptions compared to conventional illiquid private market solutions. Investors should carefully assess the redemption options to determine what is most appropriate for their needs. They must also consider any potential trade-offs in their sought-after illiquidity premium and whether they believe they will receive a commensurate level of return for the risk. Answers will vary for each semi-liquid strategy and individual investor appetite.
Given the semi-liquid structure, it is important that the manager has a disciplined approach both to deploying capital on a timely basis and to asset sales.
In more traditional structures managers have the flexibility to deploy and liquidate over time. By introducing liquidity, managers need to deploy the capital quickly to avoid a cash drag while resisting pressure to lower underwriting standards. Additionally, to satisfy redemptions managers need to sell assets to meet investor orders, while avoiding becoming a forced seller.
While the availability of semi-liquid funds is increasing across private markets, private credit has been the fastest growing segment to date with assets under management and committed dry powder valued at roughly $1.7 trillion in the U.S. alone . The principal investment structures include business development corporations (BDCs), European Long-Term Investment Funds (ELTIF), interval funds and tender offers.
The growth of semi-liquid funds is likely to continue given the number of features they can offer investors, particularly when compared to traditional closed-end funds. We believe consideration of the investment characteristic of individual private asset classes with an open ended structure could possibly complement an overall strategy.
The availability of semi-liquid vehicles is rising across the alternatives space, with their largest increase in private credit. Wealth investors, like their institutional peers, want access to private markets’ potential return and diversification benefits and now that’s becoming possible.
The author is Managing Director and Alternatives Specialist for Morgan Stanley Investment Management