The great rush into private assets by mainstream fund managers is a marvel to behold.

My colleague Selin Bucak has been very ably chronicling this structural shift, highlighting research by Citywire that shows that the world’s 25 largest traditional fund managers by assets under management run more than $2.9tn (£2.6tn) in private assets and wider alternatives.

For someone with as many grey hairs as me, this story sounds familiar. I’m old enough and ugly enough to remember the last great mass stampede. Back in the late 90s and 00s, every traditional asset manager was keen to extol the virtues of their liquid alternatives unit, at the time known as hedge funds or absolute returns.

Suddenly every Tom, Dick and Harriet was running long/short money, poaching young masters of the universe and promising absolute returns through the cycle. It all came to nought of course, because of one great weakness: performance, or a lack of it.

When push came to shove there just were not enough viable liquid trades and enough verifiable strategies that survived contact with reality to make the grade. Within a few years of the global financial crisis, many funds had been shuttered and interest had moved on.

History repeating?

The cynic in me wonders whether the same will happen again. A new elixir for a rewarding corporate life has been found and it comes in the shape of private assets: private equity, private credit, real estate opportunities and of course liquid alternatives (lurking on the fringes, suitably repackaged).

But there has been a structural change and it is one that this new gold rush is sensibly seizing upon.

Put simply, public markets have shrivelled and are a pale reflection of their former selves. We’ve collectively overregulated public markets so much that many sensibly run companies have now decided that they are better off going private.

Disappearing world

Index firm Morningstar recently launched a set of global Unicorn indices – more on that later – which was in part based on the central insight that the number of publicly listed companies in the US has declined from a peak of more than 8,000 in 1996 to roughly 4,000 today.

As the world of large, relatively liquid private companies has grown, we’ve seen a commensurate increase in their debt facilities. This trend isn’t going away, not least because the burden of regulation on public companies grows ever more burdensome by the year.

Another parallel driver has been the widespread admiration – bordering on adulation – for the endowment model, pioneered by the big US university endowments. This has shone a light on the use of alternatives, with real asset backing, in relatively illiquid asset classes, with a resulting premium in terms of long-term performance.

And given these trends, it’s not surprising that we’ve seen one last trend – the struggle to democratise these private asset strategies by developing ever more liquid fund structures assisted by innovative new technology platforms such as Prometheus and Moonfare.

This time probably is different from the hedge fund-lite model of a few decades ago. But in thinking through this new world, I do think it useful to hold in our mind different frameworks for understanding this emergent business model. When everyone was trying to copy the hedgies, I used the same framework, and it serves a purpose today. In these regular columns, I’ll return to four ways of understanding the private asset push: liquidity, accessibility, performance and valuations.

We’ll start with valuations.

Hard to believe

Understanding what an asset is truly worth must be the foundation on which any investor starts their journey and I would suggest that, at the moment, this is a tricky exercise because the elephant in the room is that private businesses are difficult to value.

If we want to understand just how difficult that exercise is I suggest we start with the biggest segment of the private assets world: private equity.

The cynic may argue that ‘mainstream’ fund managers have moved so aggressively into all things private because the big private equity houses have moved aggressively into traditional fund manager land – but with a twist: they can offer ‘exclusive’ access to alternative assets in a more liquid structure. Faced with this massive land grab – PE turning into alternative specialists – the counterreaction was inevitable.

But private equity has always struggled with valuations. Of course, there are very clear financial accounting rules that suggest clear methodologies for valuing private assets. But investors have long learnt to treat these slow-moving valuations with considerable caution.

The easiest way of seeing this is through the lens of the most volatile bit of the PE spectrum, the venture capital folks. I mentioned the Morningstar research earlier and the new series of Unicorn indices. In fact, there are 11 of these indices within the family of the Morningstar PitchBook Global Unicorn indices.

You won’t be surprised to learn that these indices have an obvious sector bias – tech businesses comprise 48% of the value of the indices.

Nor are you likely to be shocked that the close-to-real-time valuations plugged into these indices are not the preferred ones used by VCs. The daily values for private companies are, according to Morningstar, ‘estimated based on the mark-to-model valuation methodology’ – not past deals. One of the accompanying white papers explaining the index demonstrates past returns with a nice linear, upwards chart for past deals methodology, while the mark-to-model methodology shows a marked decline in valuations since the new year.

Wooden Ark

And this shouldn’t of course come as any great surprise. Take one debatable reference point – the ARK Innovation ETF, run by Cathie Wood, perhaps the most high-profile tech evangelist there is.

Wood so far has dealt in the publicly listed realm and her fund features some of the most interesting small- to mid-cap high-growth firms. Many have only recently listed and had been backed by big VCs.

Now Wood is moving to the private side, announcing her own private assets VC fund for retail investors in the next few months.

Year to date, the Innovation ETF is down a whopping 60%. Using that as a reference point, it’s reasonable to assume that private businesses with a similar growth trajectory sitting in private VC portfolios are probably down by more than that.

Yet I still see listed venture capital funds posting numbers showing that their portfolios of private businesses have increased in value this year.

Really? Current market pricing for these listed funds suggests that, in reality, very few investors agree, with some listed VC funds mired in 50% discounts.

Where’s the value?

The bigger point is obvious. Are the current valuation methodologies fit for purpose? Even mark-to-model methodologies are open to questioning.

Take the music royalty subsector, one that has seen massive expansion with all manner of alternative asset players moving in, including the giant Blackstone. Mark-to-model using cashflow estimates are widespread, as are previous deal marks. But in reality, the number of buyers of large royalty portfolios is very limited. So if a key player has to run a fire sale for instance, who believes that the current models will stand the test as the small circle of buyers and sellers closes rank?

Or what about standard buyout PE where valuations are either held at cost or use historic deal data where secondary market transactions frequently involve sales to other PE houses rather than trade buyers? I’m sure there’s a valuation rationale there but in times of stress where market liquidity dries up, I’m not sure I’d trust these methodologies.

At this point, the experienced private assets investor would counsel patience and fortitude. Stick with the plan, think long-term, and wait for the LP to mature.

Of course, that is the right attitude to take – but try telling that to pesky retail investors who’ve been lured into the various private asset classes. Squaring illiquidity, valuations and easy accessibility won’t be easy.