Private markets, semiliquid funds, and the firms that offer them are each different.
In early September, our manager research team will launch its first set of Morningstar Medalist Ratings for semiliquid funds. Like mutual funds and exchange-traded funds, we evaluate them on key factors such as investment process, management, performance, and fees but adapt our established approach to the unique characteristics of semiliquid structures. In this article, we’ll explore the key role of the parent firm. We also examine performance, investment process, management, and fees in related articles.
As is the case with asset managers focused on public markets, the Parent Pillar zooms out from individual strategies and portfolio managers. It evaluates a firm’s ability to attract, develop, and retain talent as well as its approach to succession planning. It considers whether risk management is appropriate for the asset managers’ strategies. The Parent assessment values long-term thinking, transparency, and fair fees. It appreciates rigorous product development and honest capacity management.
Essentially, the Parent rating answers whether an asset manager puts stewardship ahead of salesmanship.
There are additional considerations for alternatives managers, but they all fit inside the three buckets of Morningstar’s existing Parent-rating framework: investment organization, business practices, and regulatory engagement.
But First, How Morningstar Determines Parent
A parent is the firm offering the fund and controlling who manages it, how much it costs, and how much money it takes in through what distribution channels. The parent also is accountable for performance and regulatory compliance.
Firms have collaborated more to offer funds focused on private markets. Traditional public market asset managers have partnered with alternatives managers to develop strategies. For the managers, it seems like a win-win situation: Public market asset managers get quicker and probably cheaper access to private asset deals and operational insight, while private market managers get an “in” to public market asset managers’ existing retail or wealth channel distribution networks. American Funds parent Capital Group, for instance, has linked up with KKR to offer public/private hybrid funds; State Street Investment Management and Apollo Group teamed to offer SPDR SSGA Investment Grade Public & Private Credit ETF; and Wellington Management, Vanguard, and Blackstone will offer public/private funds under Wellington’s name. While all parties are accountable for performance and other things, one is ultimately accountable to the fund board and fundholder—that’s the Parent firm in Morningstar’s semiliquid ratings methodology.
Meanwhile, alternatives firms, such as Cliffwater, have launched their own semiliquid funds. Many traditional asset managers are also developing semiliquid funds for the first time, while others, such as Pimco, have offered semiliquid vehicles for some time.
The Heart of an Asset Manager Is Its Investment Organization
Evaluating a firm’s investment organization is critical to determining its Parent rating. The main question is whether talented investors can build careers there and whether any investment skill will persist through generations. We look at portfolio managers’ fund, firm, and industry tenure and consider how the firm manages key-person risk through succession and contingency planning. We also search for centers of investing excellence where long-term, risk-adjusted performance has been strong and investment teams are well-supported. The same applies to semiliquid fund purveyors.
However, other factors matter for alternatives managers. One asset manager quipped that while public markets managers choose investments, investments choose private market managers. Assessing an alternatives manager’s access to deals in which to invest is as important as looking at its record and reputation. Getting into the deal is only half the battle, though. How it exits those investments matters, too. While the market environment may determine whether a manager realizes a strong gain or not, a pattern of weak or delayed sales could be a red flag. For fixed-income managers, deferring interest payments or accepting payments in kind too often could be signs of deficient underwriting.
Valuation practices can also affect a private market manager’s Parent rating. Private market valuations can be subjective because they don’t have the benefit of daily transactions. Our fund assessments attempt to discern whether a firm’s valuation practices are conservative or aggressive by examining deviations compared with public information or changes over time; at the parent level, the firm’s long-term track record, identifiable patterns, and governance pertaining to valuation comes into frame. Semiliquid fund managers across the board could improve transparency on valuation practices; those that do are more investor-friendly.
Finally, how firms use incentives to retain senior leaders and investment professionals and align their interests with their clients’ is important to the Parent rating.
A Firm’s Commercial Ethos Can Be Telling
What a firm sells and how is key. The parent analysis evaluates public markets firms’ product development approaches, specifically whether they offer strategies with enduring investment merit that investors can use well. Firms offering semiliquid funds should also think about how their funds fit in an investor’s portfolio, especially considering the long-term nature of private assets.
Responsible marketing and transparency also reflect a firm’s culture. Private market managers are known for requiring nondisclosure agreements for outsiders and clients to access even basic performance and valuation information. Financial advisors, however, are accustomed to more transparency. While there may be some good reasons for private market managers to play their cards close to their vests, they need to rethink what they need to share with investors to help them use their products well. Mutual fund and exchange-traded fund providers have learned the hard way that it’s not worth having clients that aren’t a good match for them, and better alternatives managers will realize this sooner rather than later.
Morningstar has long stressed the importance of fees to investors’ results. Public market fund fees have persistently been the most important predictor of future results. There’s little reason to believe semiliquid funds will be different. At this point, private assets funds are more expensive and regularly include performance-based fees. As semiliquid funds’ transparency increases and they become more mainstream, there’s room for disruption on the fee front.
Follow the Rules
Breaking regulatory rules in a way that is costly to clients, reveals compliance deficiencies, or highlights conflicts of interest would likely result in a Parent rating downgrade. That’s true no matter what an asset manager is selling. Although some regulatory settlements may not be that serious, asset managers are expected to follow the law.
Morningstar’s Parent analysis assesses whether a firm has nurtured a culture centered on stewardship and on giving investors a positive experience. Where there is limited liquidity, more valuation subjectivity, less transparency, and higher fees, an investor-friendly culture makes it easier to pull off the kind of long-term commitment semiliquid funds require.
