The push to bring private markets into the ETF wrapper is gaining momentum as a growing number of investors seek private investment opportunities. And with the number of publicly listed companies declining and private markets expanding, asset managers are looking for ways to bridge that gap for retail investors.

“You saw banks pull back their lending and their participation in the capital structuring of companies,” said Jerry Prior, COO and CIO of Managed Futures at Mount Lucas Management in a recent episode of The ETF Show. “And, ultimately, what ended up happening was that moved into private assets, private private equity, private real estate, and private credit.”

He explained that the “goal” of bringing this into the ETF wrapper, is “to give access to retail investors that institutions have had access to for the last decade.”

But as access expands, so do concerns. Especially about liquidity.

ETFs are designed to trade intraday, but private markets as an underlying asset are often less liquid than the wrapper needs. That mismatch can be confusing for investors who associate the ETF structure with true liquidity.

“While you have liquidity within the ETF wrapper, the underlying constituents might not be liquid,” Prior said. “Any time markets start to freeze up, what you think is a liquid ETF investment is not.”

The disconnect becomes most important during periods of market stress and volatility, when pricing in private markets can fail to reflect real-time conditions. In those environments, investors may believe their portfolios are more stable or more diversified than they actually are.

Often, privates are grouped into the category of “alternatives” as private equity and private credit are viewed as diversifiers. But Prior believes we should rethink that designation.

“We coined a term internally-—instead of calling them private equity and credit alternatives, we call them ‘equalatives,’” he said. “They’re equal to public equity and public credit but they have the same underlying economic drivers, but there’s that underlying illiquidity.”

In other words, private assets may not provide the diversification investors want. They just repackage similar risks in a different structure.

And that becomes a problem when markets turn volatile. Diversification is only useful if it can be acted upon; particularly through rebalancing. And rebalancing requires liquidity.

“That diversification doesn’t mean anything unless you can monetize that diversification,” Prior explained. “And you can’t do that without liquidity.”

In practice, that can lead to unintended portfolio outcomes if private assets are not repricing in line with public markets. In that circumstance, investors may find themselves increasingly overweight in illiquid exposure, and unable to rebalance as conditions change.

Prior sees a need for liquid alternative strategies, such as managed futures and global macro. He believes these approaches offer exposure to a broader set of economic drivers like commodities, currencies, and interest rates, and enable an investor to take both long and short positions.

“All the things that drive a strategy like ours are the things that hurt equities,” he said, pointing to the opportunity for true diversification.

Despite his concerns, Prior isn’t dismissing private markets altogether.

“I don’t have anything against investing in private assets,” he said. But he did emphasize the need for education and for measured allocations.

“Don’t confuse the ETF wrapper with liquidity,” he explained. “And probably, limit the size. I certainly wouldn’t fill up my portfolio with these things.”

Source: The ETF Show - Private Market ETFs Have Huge Demand, But Liquidity Concerns