Private markets assets under management (AUM) have experienced explosive growth over the past decade, increasing, our analysis shows, from $3.8 trillion1 in 2014 to $13.1 trillion2 during a period of historically low interest rates and expanding deal volumes, and an increasingly globalized economy.
Macroeconomic conditions over the next decade will be quite different.3 Private markets have entered a slower era of growth, with near-term fundraising challenges. Yet it is our view that private markets’ AUM could triple (again) to over $30 trillion by 2034, supported by new investment needs, new sources of capital, and private capital’s “governance advantage,”4 which continues to create superior returns for the industry relative to public market comparables.
Firms that don’t, at a minimum, triple in size over the next ten years could structurally lose market share, find it increasingly difficult to remain relevant for large capital allocators, and face challenges in attracting and retaining some of the best talent entering the industry.
Based on our extensive experience across the private markets ecosystem, serving general partners (GPs), institutional investors, private-wealth intermediaries, and traditional asset managers, we believe firms in the next decade will need to leverage what we call the “five alphas” to outperform. Excelling against two or three alphas while meeting a (high) minimum acceptable standard on the rest can create a path to outsize growth and returns.
Sales alpha
Sales alpha is the extent to which firms are able to raise more capital on better terms than their “fair share” (for example, for a given track record of performance and set of market conditions).
The power of sales alpha is clear in the current fundraising drought. From 2021 to 2023, total capital raised by private markets firms declined by 17 percent per annum to a little over $1 trillion, but the number of funds launched declined by 39 percent per annum.5 Last year, the top 25 private markets managers accounted for 41 percent of overall fundraising, compared with average levels of 29 percent over the prior decade,6 with even wider gaps among leaders and laggards in specific asset classes such as infrastructure.
Firms that are able to buck capital droughts build capital-raising machines that do the following:
- expand their geographical reach (for example, beyond US public pension funds to sovereign-wealth funds in the Middle East and Southeast Asia)
- use insurance balance sheets as a source of both permanent capital and material management fees, particularly for credit and real estate strategies
- tap into the vast ultra-high-net-worth families and retail-investors market7 (which some private asset managers expect to account for more than 30 percent of their fundraising going forward8)
- innovate with new product vehicles to meet new investor needs, such as nontraded real estate investment trusts (REITs), business development corporations (BDCs), and interval funds and other semiliquid structures, which reached around $241 billion in private markets AUM in the United States alone in 20229
- begin to access large corporate entities as a new source of strategic capital
Firms with strong sales alpha are not necessarily the top quartile funds in every vintage; instead, they may have developed strong brands and deliver on their performance objectives in ways that meet the needs of limited partner (LP) portfolios. For example, they may consistently deliver 900 basis points of outperformance relative to public markets at scale over extended periods, or they may provide material upside in favorable market conditions (for example, 30 percent-plus) while capping the downside to a pension’s hurdle rate (for example, 8 percent).
These firms often develop product suites and a capital structure they can adapt to match capital to the opportunity set, as well as client coverage and engagement models that are both systematized and segmented. They also embrace the mindset that raising capital is as critical to a firm’s success as investing capital. They invest in their distribution engines accordingly, with investment teams carving out 15 to 25 percent of their time for fundraising, and they take a strategic approach to partnerships with institutional limited partners, wealth intermediaries, and large companies.
Sourcing alpha
Sourcing alpha is the ability to manufacture new bespoke investment exposures (that is, specific return, risk, and duration profiles) rather than rely solely on intermediated deal flow. To achieve sourcing alpha, firms need a high degree of creativity to craft attractive transactions, paired with a sophisticated capital allocation process. They also need a broad product suite to meet different investor needs.
Next-generation sourcing creativity, for example, was observed in a number of recent partnerships between large infrastructure platforms and established companies across industries such as semiconductors, fiber, power generation, and life sciences. Among the examples are Brookfield’s $15 billion investment in Intel’s manufacturing expansion,10 KKR’s purchase of 30 percent of Telenor’s fiber business,11 BlackRock’s Gigapower joint venture with AT&T,12 and Blackstone’s financing deal with Moderna.13
Such opportunities stem from employing ecosystem-level approaches to sourcing, spanning multiple sectors and themes, as well as innovative capital structure angles (such as common equity, preferred equity, or project-level debt financing). In this way, firms can create larger deals that are derisked and divorced from the cyclicality of a given sector.
Firms will need to shift their approaches to sourcing away from a sector-specific view and toward the functional ways that opportunities present themselves in the market (for example, digitization and decarbonization). Firms can introduce more fluid collaboration across investment teams. They should employ talent with diverse skill sets—including individuals with corporate-development experience and a partnership/M&A mindset and experience—who can work with traditional deal partners.
Sourcing alpha can be generated through partnerships—between venture firms and university labs, for instance, or between credit managers and originators of liabilities. For good examples, consider Apollo Global Management’s 28 partnerships leading to $200 billion in asset-backed origination as of November 2023,14 or Centerbridge’s partnership with Wells Fargo15 to secure direct-lending opportunities. Those capable of producing sourcing alpha can pair this opportunity-manufacturing engine with a “return tranching” capability that carves out a given transaction into distinct exposures that can be matched to each investor’s parameters (return, duration, liquidity) and packaged into portfolios meeting specific investment objectives.
Operational alpha
This source of alpha—also described as postacquisition value creation—takes on new importance in an era of higher interest rates, inflation, and uncertain public market exits.
Consider this example: a private equity transaction with typical leverage must achieve a two to four times increase in cash flow CAGR over the course of its holding period if it is to absorb a 400-basis-points increase in the cost of debt, without eroding its original planned return.16 If public market uncertainty adds another year to the holding period, about 10 percent more in incremental earnings will be required to produce that same return. The problem is compounded when adding inflation and longer investment horizons (created by the rise of permanent capital vehicles, co-investors with patient capital, long-dated funds, and continuation vehicles).
“Plain vanilla” operational improvements (such as G&A trimming and pricing enhancements) are now table stakes. Achieving outsize returns from operational alpha will require firms to develop the conviction to underwrite and the muscle to deliver truly transformational change. They can do this by, among other initiatives, creating new business models, divesting portfolios at scale, reducing the drag on working capital, building new businesses and launching new products, delivering technology improvements beyond enterprise resource planning systems and cloud transformations, and securing major capital efficiency improvements. Part of the muscle should come directly from the portfolio company CEO, who has an outsize impact on any deal’s performance as the integrative executive and the “face of the business” to its owners.
For private markets firms, distinctiveness in operational alpha requires the following:
- a precise view of each asset’s full potential across all strategic, commercial, and operational transformation levers
- a disciplined approach to maximizing the return on intervention—in our experience, few assets account for a disproportionate share of the potential equity value gained in a given fund
- an “exit first” mindset that factors in the future asset owner’s objectives in the pacing and ambition of value creation initiatives and matches the delivery of that value to anticipated exit windows
- a talent network to source new and replacement board members and management teams
- a proven approach to upskill CEOs across operating essentials (that is, a set of capabilities that are proven to move the needle on company performance, such as rapid resource allocation) and an ecosystem of third-party partners who optimize expertise, reduce the fixed cost to the firm, and link their compensation to the achievement of specific outcomes
Exit alpha
Firms producing exit alpha are able to monetize assets successfully in a range of ways and market conditions. As one CEO told us, “DPI17 has become the new IRR, so mastering exits is now both the alpha and omega in private markets investing.”
Exit alpha matters, especially now, when rapid changes in the macroeconomic environment are having an outsize impact on the liquidity of private markets.
In 2021, favorable market conditions propped up overall global exit volumes to record highs (approximately $2 trillion, compared with $1 trillion in 202018) and helped some firms post their highest fund realizations ever. In 2023, all three traditional exit pathways—secondary buyouts, sales to strategics, and IPOs—floundered, and volumes collapsed, both in absolute terms to $840 billion,19 as well as on a relative basis (falling to 1.4 percent of the overall AUM versus a 3.3 percent average over the prior decade20).
Firms that demonstrate exit alpha develop a range of exit routes, such as:
- GP-led continuation vehicles (which, at volumes of $48 billion21 in 2023, are emerging as a distinct sub-asset class)
- long-hold institutional structures, potentially with long-term, yield-oriented payouts
- retail-oriented vehicles that have been used as exit pathways in credit but require further evolution before they can be applied to private equity and infrastructure
These firms also perform a systematic and disciplined re-underwriting of each investment every six to 12 months, based on consideration of their go-forward returns, outlook for capital market sentiment, portfolio-level risks, and the overall fund deployment and realization profile.
Most of all, GPs that achieve exit alpha are always obsessing about who the next owner of their assets could be and how to go about returning cash to the fund and its limited partners. This focus could be a major source of differentiation in the next era, given investors’ increased preference for true cash returns over paper gains.
Organizational alpha
Organizational alpha involves designing the firm’s structure and operating model around three elements:
- client-centricity, with a capital-solutions mindset that designs new strategies and products to meet the needs of LP portfolios and delivers nontraditional structures (for example, separate accounts, co-investments) that support LP investment objectives
- repeatability, with just enough process to compensate for the loss of proximity in a growing firm, maintain a consistently high bar for investment performance, and eliminate damaging outcomes
- scalability, with a modular architecture to acquire and integrate new assets and new talent, investments in data and technology to strengthen the firm’s spine, and strong governance and succession planning at all levels (not just at the top) to preserve entrepreneurialism in a bigger firm
Successful firms have engineered and industrialized their flagship processes end to end (investment and portfolio committees, client engagement, partner elections, compensation) to create consistent outcomes while preserving their cultural fabric as they scaled.
The private capital industry has grown from strength to strength over the past half century. Near-term fundraising challenges notwithstanding, we expect the industry’s growth trajectory to continue over the long term.
The five alphas we describe in this article touch every important facet of a private markets firm: fundraising, investments (and how firms go about sourcing their deals), operations, exits, as well as the organizational structure and operating model. Firms that build the capabilities needed to achieve these alphas have the potential to become the next generation of outperformers in private investing.
