Morningstar's Kunal Kapoor on Due Diligence in Private Markets

Morningstar's Expansion into Private Markets

• 💡 Morningstar, known for its ratings on public market funds, is now extending its due diligence to private markets, including private credit, private equity, infrastructure, and real estate.
• 🎯 This expansion aims to help investors navigate the less transparent private market sector, offering insights and ratings similar to those provided for public funds.

The Rise of Private Markets

• 🚀 The private markets have seen a significant influx of capital, with the number of private equity-backed companies in Europe alone doubling compared to public companies.
• 📈 While the public markets still hold higher-value companies, the size of private companies is growing, leading to more investment opportunities shifting from public to private.
• 🏦 Post-Global Financial Crisis, regulatory changes and a more cautious approach by big banks opened the door for non-banking lenders, particularly private equity firms, to step into private credit.

Understanding Private Credit

• 💬 Private credit involves companies unable to or unwilling to borrow from traditional banks, seeking alternative funding from private entities.
• ⚠️ A key distinction is that this debt is often illiquid, meaning it doesn't trade on a listed exchange and tends to be held privately.
• ⚖️ While skepticism about private markets is warranted due to potential for lousy products, firms like Blackstone and Apollo bring established reputations and research capabilities.

Private vs. Public Market Performance and Correlation

• 🤔 The traditional view of private equity outperforming public equity is being questioned, especially as interest rates rise, potentially leading to a swing back towards listed equities.
• 📊 While private markets may offer a slight return premium for illiquidity, data suggests a higher correlation between public and private markets than many investors believe.
• 🧩 The benefit of private equity's longer holding period is that investors are not trying to trade in and out, which can influence perceived returns.

Semi-Liquid Funds and Due Diligence

• 🗓️ Semi-liquid funds, such as interval funds in the US and LTIFs in Europe, offer scheduled liquidity (e.g., quarterly) allowing managers to invest in less liquid assets.
• 🔍 Morningstar's ratings for these vehicles aim to answer whether they add value and provide a premium for reduced liquidity, putting public and private markets on a more equal footing.
• 💰 The rating methodology will assess management's ability to deliver outperformance and consider key factors like expenses and fees, bringing transparency to the sector.

Allocation to Private Assets

• 🏠 For most retail investors, simplicity is key; if a public market portfolio allows them to sleep at night and hit their goals, there's no need to change.
• 📈 For those interested in private markets, starting with a small allocation (5-10%) of retirement assets is recommended to understand their behavior and liquidity characteristics.
• 🇬🇧 The idea of obliging pension funds to allocate a portion to private markets is seen as positive for long-dated asset pools, though prescription is not favored over professional judgment.