Why Private Markets Cannot Be Managed Like Public Markets
Introduction
Private markets have become an increasingly important part of many pension fund portfolios. The arguments are well known: diversification, access to specific markets, potential illiquidity premiums and, in some cases, the opportunity to achieve sustainability or impact objectives.
Yet one observation stands out. Many pension funds continue to approach private markets using governance and decision-making processes that were largely designed for public markets. That can create significant risks.
“The question is not whether a pension fund should invest in private markets. The question is whether it has the governance capabilities required to do so responsibly."
John Renkema, Partner Avida and Head of Private Markets
Private Markets Are Fundamentally Different
When investing in publicly traded securities, trustees can generally adjust course when circumstances change. Positions can be reduced, managers can be replaced and strategies can be refined.
Private markets are different.
Investments are often made with a horizon of ten, fifteen or even twenty years. Decisions taken today may have consequences for the fund throughout that period. Exiting an investment early is often impossible or can only be achieved at a significant cost.
This requires a different way of thinking—not only about the investment itself, but also about the decision-making process that precedes it.
The Challenge of Information Asymmetry
A second key difference is the degree of information asymmetry.
In private markets, fund managers often possess substantially more information than the investor. In addition, the complexity of these investments requires specialist expertise that may not always be readily available around the board table.
Trustees should therefore ask themselves:
Do we sufficiently understand the underlying risks?
Do we have access to independent expertise?
Are the right questions being asked before commitments are made?
Is it clear how conflicts of interest are managed?
These questions are crucially important because decisions cannot easily be reversed.
Sustainability and Impact: What Will We Think in Ten Years' Time?
For many pension funds, sustainability and impact are key reasons for investing in private markets. These asset classes can provide direct exposure to areas such as the energy transition, infrastructure and social development projects.
Yet this is precisely where governance challenges emerge.
Societal views evolve. What is considered desirable today may be viewed differently in five or ten years' time. An investment that is currently presented as a meaningful contribution to sustainability or social progress may become the subject of debate in the future.
Looking back just a few years demonstrates how quickly priorities can shift. Not long ago, many institutional investors sought to distance themselves from anything related to the defence industry. Following the war in Ukraine, many of those same organisations are now debating whether defence investments contribute to security, societal resilience and even certain sustainability objectives. The example illustrates how rapidly societal and geopolitical perspectives can change.
For investments that may remain in a portfolio for twenty years, it is therefore prudent to look beyond today's arguments and think ahead. Will we still be able to explain and justify this decision to our members five or ten years from now?
"Private markets require more than a different investment strategy; they require a different governance mindset. Decisions that cannot easily be reversed deserve a higher standard of scrutiny."
Gerben Schreurs, Managing Partner Avida Netherlands
From Due Diligence to Pre-Mortem
Traditional due diligence focuses on opportunities, risks and investment terms.
In private markets, it can be valuable to complement this with a pre-mortem exercise: imagine that this investment is considered a failure ten years from now. What might have caused that outcome?
Questions could include:
Which assumptions may prove incorrect?
Which societal developments have we underestimated?
Which governance risks have we failed to adequately consider?
What questions might members ask us in hindsight?
This exercise encourages trustees to look beyond today's investment memorandum and business case.
Governance That Fits the Asset Class
The growing interest in private markets is understandable. For many pension funds, these investments can play a valuable role within a diversified portfolio.
However, the governance surrounding private markets deserves at least as much attention as the investments themselves.
When making a commitment that may last twenty years, trustees should be confident not only in the expected financial return or societal impact, but also in the quality of the decision-making process underpinning that commitment.
Private markets are not simply public markets without a stock exchange listing. They are a distinct asset class that requires a different governance framework, different discussions at the board table and a different approach to organising expertise and challenge.
Asking the Right Questions Around the Board Table
For many pension funds, the challenge is therefore not whether to invest in private markets, but how to organise the governance surrounding those investments. This requires an investment process that takes account of the specific characteristics of illiquid assets, access to independent expertise and sufficient room for constructive challenge.
At Avida, we see that many pension funds have well-established investment processes in place. However, private markets place additional demands on governance and decision-making. We support boards and investment committees in the strategic design of their private markets programmes. This includes helping to define the strategic objectives of these investments, determining annual investment and commitment levels, manager selection, governance reviews, independent second opinions and the critical assessment of investment proposals.
Not to make decisions on behalf of trustees, but to ensure that the right considerations are brought to the table before a fund commits capital for the long term.
