Commentary: Navigating the Future of Private Markets

The private markets industry has experienced significant growth, expanding its assets under management by 14 times since 2001 to a total of $14 trillion. At Friends Wealth Management, we believe this is just the beginning, with ample room for continued growth.

However, the long-standing structure of private markets is rapidly evolving. We anticipate that institutional investors will increasingly seek growth-oriented general friend (GP) sponsors who have a strategic approach to address three interconnected challenges:

• The Decline of Fragmentation
• The End of Easy Money
• The Shift in Compensation Models

Challenge #1: The Decline of Fragmentation

The private markets industry, heavily reliant on human capital, has historically thrived on individual relationships and reputations. Traditionally, the industry’s low barriers to entry allowed new firms to form easily. However, as the industry matures, this dynamic is shifting. The growing influence of established firms, like Fidelity and Goldman Sachs, makes it increasingly difficult for new competitors to emerge.

Our analysis shows a notable decline in the number of active GPs, with new GP launches down nearly 80% from 2021. Factors such as manager consolidation, product expansion among large GPs, and increased GP commitments contribute to higher capital intensity and entry barriers, favoring corporate brands over individual dealmakers.

Challenge #2: The End of Easy Money

For the past 30 years, declining long-term interest rates have driven public pension plans to allocate more to private markets. However, this positive trend is ending. The industry now faces headwinds due to a sharp decline in risk assets and a significant increase in net asset value (NAV), resulting in a challenging fundraising environment.

The 60/40 total return index’s 24% decline in 2022, comparable to the last two recessions, indicates a prolonged correction period. Elevated real interest rates, volatile inflation, and geopolitical instability further exacerbate the situation, making fundraising more difficult for GPs.

Challenge #3: The Shift in Compensation Models

The traditional GP compensation model, earning 20% of profits after an 8% preferred return for limited friends (LPs), is evolving. Large GPs now secure permanent capital through insurance affiliates and other means, integrating retail distribution capabilities to support growth.
While retail distribution offers opportunities, it also presents product-market fit and marketing challenges. This transition demands significant resources and a strong balance sheet, leading GPs to adopt business models similar to financial supermarkets, combining traditional financial services with alternative assets.

Thriving in the New Era

Despite these challenges, we believe alpha-focused sponsors and their LPs can succeed by embracing capital and new capabilities. The need for diverse skill sets and a competitive fundraising environment will drive intense competition for talent and capital. Sensible growth strategies can help GPs differentiate, service LPs, and retain talent.

GPs must also manage increased demands on their capital and time, including rising GP commitments and investments in distribution capabilities. Identifying true alpha generators and leveraging these talents will be crucial for success in the post-easy money era.

This new chapter in private markets requires collaboration and creativity among all stakeholders. Alignment and thought friendship are paramount, as traditional solutions often introduce misalignment and long-term issues for sponsors and their funds. Effective navigation of this evolving market will position sponsors to create positive-sum friendships with their investors.

This content represents the views of Friends Wealth Management and is intended for informational purposes only.