Liquidity management in private market funds

CI GAM's balanced approach to private market funds for institutional investors

Liquidity management in private market funds

This article was produced in partnership with CI Global Asset Management.

Private markets have become a cornerstone of institutional investment strategies, increasingly preferred by a wide range of asset owners, including sovereign wealth funds and endowments. This growing interest is attributed to their potential for higher returns and the opportunity to diversify away from the more volatile public markets.

Private markets have undergone significant evolution, broadening their scope to include a diverse mix of industries, geographies, and types of capital claims.

A key distinction between private and public markets is their liquidity. CI Global Asset Management’s (GAM) Marc-André Lewis addresses the challenge of managing liquidity in private market investments, acknowledging the inherent limitations due to the less liquid nature of these assets.

He outlines that private market investments are suited for individuals with medium to long-term investment horizons, noting that not everyone requires their entire portfolio to be fully liquid at all times. This leads to the possibility of allocating a portion of one’s portfolio—perhaps 5 to 15 percent—to investments that can be locked in for durations of 5 to 15 years, aligning well with private market investments.

Mitigating liquidity limitations

Lewis explains that CI GAM’s private market funds implement “gated liquidity,” allowing investors to redeem or invest on a quarterly basis. This approach is designed to balance the needs of those wishing to withdraw against the interests of those remaining in the fund, ensuring fairness due to the limited liquidity of the underlying assets.

To mitigate these limitations, a portion of the fund is invested in listed assets such as equities and bonds. Additionally, the fund diversifies across various “vintages” in private markets, deploying strategies that yield returns at different times, thus enhancing the fund’s ability to provide liquidity.

Beyond these strategies, the fund employs extensive quantitative analysis and simulations to prepare for stressed market conditions. This risk management approach aims to ensure that the fund can meet its liquidity commitments even during challenging times.

“Private credit has become a key focus in our investment strategies lately, Lewis says, “We're targeting high-quality companies with substantial assets that serve as collateral for our loans, which adds a layer of security to our investments.

“The growing interest from institutional investors in increasing their allocations to private credit underscores its significance. This heightened demand signals the need for us to be more discerning in our investments. With more investors eyeing this asset class, there's an increased risk of overvaluation in certain areas. Our strategy, therefore, includes careful selection to identify genuine value and avoid overpriced segments.”

Opportunities in secondary markets

When it comes to private equity, CI GAM’s strategy is distilled into two main methodologies for value creation: financial engineering and operational efficiency. Financial engineering involves the acquisition of companies followed by an increase in their leverage, which is subsequently reduced through cash flow management. However, the primary focus shifts towards operational efficiency.

This approach entails purchasing underperforming businesses and substantially improving their operations through the intervention of expert teams. CI GAM is placing an emphasis on operational efficiency over financial engineering within its private equity investments. This shift is a strategic response to the changing dynamics of the market, where higher interest rates make the traditional leveraged buyout model less effective.

Secondary markets present an opportunity for CI GAM, as increased participation in private markets leads to situations where investors may need to liquidate their assets. By positioning itself to buy in these circumstances, CI GAM can capitalize on market inefficiencies to the benefit of its clients.

The strategy includes forming partnerships with funds dedicated to industrial revitalization, identifying inefficient operations within companies or their specific plants, and implementing comprehensive enhancements, particularly in IT infrastructure and production line efficiency, to significantly increase business value for a profitable exit.

Being on the purchasing side during forced sales situations offers a strategic advantage, allowing them to capitalize on the urgencies of sellers, thus aligning with a profitable investment approach in the private market space.

Climb through the window of opportunity

“Currently the window for private credit is open, and it might be that in the next five to 10 years, that window closes,” says Lewis.  As the current cycle of interest rate increases tests the financial system—evidenced by some failures—once rates begin to decline, we might see a more stable and healthy environment conducive to synchronized growth, which could benefit banks.

Within their balanced funds, CI GAM leverages a strategy that includes private assets, adjusting their exposure over time based on market conditions. This adaptability is crucial, enabling them to maintain an attractive position in private markets while being prepared to modulate their exposure as circumstances evolve.

“Private credit offers exceptionally attractive returns, potentially reaching low double digits. These returns are perceived to have higher expected outcomes compared to what listed equity markets might offer over the next decade. This presents a remarkable investment opportunity from our viewpoint,” maintains Lewis.