Billions in capital calls threaten to wreak havoc on global stocks and bonds

(Bloomberg) — The private market is rallying — and threatening to wreak havoc on global stocks and bonds.

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As financial conditions tighten around the world, private market funds are asking investors to put up more than the money they pledged during the easy money days of the pandemic.

While many large pensions and endowments are expected to have sufficient cash flow to meet these capital demands, the fear is that large numbers of other investors will have to offload liquid assets to meet the obligations. That would likely mean even bigger losses in public equity and debt markets, where returns have already fallen more than 20% this year.

The first signs of trouble are evident in the shrinking distributions these private-market partnerships provide to investors, according to data from Burgiss Group LLC.

Five of the six categories of private market funds tracked by the research firm posted negative net commitments in the third quarter, meaning investors had to pour more money into them than they got back in returns. Buyout funds posted the biggest hole, minus $7.66 billion, the most since the second quarter of 2020, the data showed.

“We see cause for concern,” Burgiss analysts Patrick Warren and Louis O’Shea wrote in a note last month. “Net allocations to venture capital are now at their lowest level in several decades, and senior and distressed debt are also demanding net capital.”

Three of the fund types distributed the lowest amount of money to investors in at least seven years.

Capital requirements have accelerated this year, particularly for private credit funds, said a senior executive at an institutional investor that oversees more than $50 billion. Portfolios known as trigger funds, which require client capital after certain thresholds are reached, are among the most active in making capital calls, the executive said, speaking on condition of anonymity to discuss internal matters.

“It’s possible to imagine large institutions engaging in forced sales of liquid public stocks to meet the capital requirement of private equity investments,” wrote Ben Eifert, founder and chief investment officer at boutique hedge fund QVR Advisors. in its October letter to investors.

Capital calls are not the only concern for private markets investors. Even their successes create headaches.

As many alternative assets have outperformed public markets in recent years, institutions have exceeded past fixed limits on the proportion of their portfolios that can be allocated to private markets.

Although this so-called denominator effect may be exaggerated – as there is a delay in the revaluation of private assets to reflect the latest market conditions – it does have the potential to trigger increased selling at a time when it is least wanted. .

And the amounts involved can be huge. Much of the easy money pumped into the financial system by central banks during the pandemic found its way into unlisted assets, which grew to $10 trillion globally by September 2021, a fivefold increase since 2007, according to data from investment data firm Preqin.

“There is something of a regime change in the macro world and in the markets that we need to get a handle on,” said Steven Klar, president and managing partner of Wellington Management Co., at the Global Financial Leaders Investment Summit in Hong Kong on Nov. 3. “We are working with our clients to consider how to really return that asset allocation in a more diversified and balanced way.”

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