For limited partners, the recent market downturn shifted more than just portfolio valuations. It changed how they’re assessing their private investment managers.
As interest rates have risen, so too has the risk-free rate — the theoretical return that an investor could make without taking on any risk, like the interest earned on a bank savings account. This has prompted investors to reconsider how they approach private market investments, according to Kim Lew, chief executive officer at Columbia Investment Management Co.
“In this environment where we are increasingly uncertain around these asset classes and the diversification that they present, people are saying, ‘What can I rely on?’” Lew said during a panel on Monday at the Milken Global Conference.
One way that allocators measure GP performance is on the basis of the value added relative to the risk-free rate. When interest rates were zero, proving that private investments added value was a totally different exercise than it is today.
“The whole argument made to us was that we were in a low-interest rate environment,” Lew said. “Now that the risk-free option is giving us 4 to 5 percent, shouldn’t you have to beat that? And how much should you beat that by to show us you’re good at this? That’s what the LPs are struggling with.”
According to Lew, this goes back to a larger question that allocators are grappling with, which is what managers have promised versus what they are delivering. During the most recent bull market, particularly in 2020 and 2021, managers began expanding into strategies that were not traditionally their areas of expertise.
A hedge fund, for instance, may have started investing in venture capital firms. Private equity managers became private credit managers too.
“It happens in every bull market,” Lew said. “There are investors that did one asset class, and then during the bull market, they do tangential asset classes. We as LPs agree to that.”
But the hurdle rates for each asset class are different, and not every manager is great at demonstrating value across different asset classes. As Lew put it: Some managers think that they are Bo Jackson — the only professional athlete in history to be named an All-Star in two major North American sports. More often than not, though, they’re more like Michael Jordan, a basketball star who only played major league baseball for one year.
“I think that there was a lot of rotation that was done to us, and our portfolios were very different than the ones that we thought that we had,” Lew said. “Now we’re thinking to ourselves, how do we unwind this?”
But despite the market’s recent downturn, Lew is optimistic about what’s next. She sees opportunities in both private and public markets.
“Everything looks attractive and unattractive at the same time,” Lew said. “A lot of people say that this is a great time for privates. And I agree. But the equity markets are down so much that there’s value to be had there too.”
