Institutional investors’ allocations, represented by public pensions, have plateaued lately. This will not be surprising given the sheer volume of capital already committed and the proven fact that private equity, the larger of the 2 allocations, has not produced comparable returns to public markets for a few years.
The reduction in latest institutional commitments coupled with a congested exit environment created pressure across the private market ecosystem. Asset managers still needed to fund large portfolios, advisors still had asset classes to recommend, and distributors still needed latest products to sell. The solution was a structural innovation that allowed the industry to expand its investor base: semi-liquid vehicles designed specifically for individual investors and marketed as a “democratization” of personal markets.
These structures typically provide regular liquidity, often through quarterly redemption windows, while investing in assets that may take years to sell at reliable prices. The appeal is clear. Investors are offered access to non-public markets with the looks of stability and the peace of mind that they will repay their capital regularly.
The problem is that this model violates the financial principle explained earlier. Long-term, hard-to-price assets should never be financed with short-term liabilities unless a lender of last resort is behind the structure. If this rule is ignored, the structure shall be unstable. As long as inflows proceed and redemptions remain manageable, this appears to be useful for each investors and fund managers. However, once investors start withdrawing capital, the discrepancy between liquidity guarantees and underlying assets becomes apparent in a short time.
History provides many examples of this dynamic. Wildcat banks within the 18th century, trust firms within the early twentieth century, and investment bank storage facilities within the early twentieth century. In each case, when confidence waned, investors tried to act rationally before others did. It doesn’t take long for investors to go away just because they’re waiting for others to go away – which is the hallmark of a bank or fund run. This risk increases significantly when individual investors provide a big percentage of capital.
Taken together, semi-liquid private credit and personal equity funds are unusually vulnerable to run mechanisms. Not only are illiquid assets funded with redeemable capital, however the underlying investments were made at the top of two long-term investment cycles. Financial history suggests that such mixtures rarely remain stable for very long. They can function easily for several years. However, as trust weakens, the structural imbalance can not be ignored.
That day got here on February 18th. as Blue Owl announced that it had permanently eliminated quarterly liquidity in its private credit fund, OBDC II.
