EDHEC: Do private equities track public markets (and when)?
By Evan Clark, Senior Private Market Analyst, EDHEC Infrastructure & Private Assets Research Institute
Higher frequency private equities data provides a dynamic view of the private equities market. With monthly pricing at the asset level, one has a current view on how market participants are pricing risk in the market. Alongside more reasonable volatility assumptions, this can be used to form longer-term expected return assumptions. For correlations, a longer-term perspective may be more appropriate given that there is an interaction among various asset classes.
A recent Scientific Infra & Private Assets (SIPA) report, ‘Do Private Equities Track Public Markets (and When)? Horizon Correlations in Private Equities,’ demonstrates that correlations can change dramatically over shorter periods of time, reflecting how quickly market participants transmit economic and fundamental news into asset prices. Given liquidity differences in public and private markets, this can lead to different return dynamics over shorter horizons.
Rolling and horizon correlations in private equity
Long-term price-level correlations between the private2000 index, S&P 500 and Russell 2000 indices are high (~0.9). However, price return correlations between private and public equity returns are time varying and can change sign, understating long-term relationships between these asset classes. Analyses using the private2000 index show that 12-month rolling correlations with the S&P 500 and Russell 2000 fluctuate significantly, falling during periods of large drawdowns in listed equities (2018, 2020, 2022). However, as the measurement window extends to 24 or 36 months, and especially when horizon-based (multi-quarter-hold-period) returns are examined, aligning with private equity investments horizons, correlations rise toward 0.4 to 0.6.
Short-term volatility and correlations matter
While long-term horizons are important for understanding correlations among asset classes, short-term, higher-frequency data is essential to understand private markets and track the current performance, value and riskiness of private asset portfolios. Recently, lower fund distributions and a slowdown in exits have pushed some limited partners to sell or explore sales on the secondary market, where there are significant discounts to reported NAVs. This has called into question the idea that private equity investors can ignore the short term. Given the high cost of transacting in secondary markets, investors need to have a current view on the price their private assets may transact at, not just the NAVs. With the development of continuation vehicles and evergreen structures, the ability to take both a short and a long-term view is key.
Long term versus short term
Rolling monthly and quarterly correlations between the private2000 index and listed equities’ indices ranges from 0.3 to 0.4. Hold period correlations, which measure returns over horizons consistent with private equity ownership, show levels closer to 0.6, even approaching 0.8 at some points. The lower shorter-term correlations indicate that the markets are different, and one cannot be effectively proxied with the other. Naturally, at longer horizons (hold periods), the correlations increase, reflecting that both are still ‘equities’ and thus influenced by similar fundamentals. With correlations well below 1, the case for diversification still exists, but less than that implied with shorter-term rolling correlations. Moreover, the disconnect in the shorter term highlights the need for reliable private equities’ data, as listed equities can diverge from unlisted equities in the short and medium term. This is where data is most needed, for benchmarking, valuations, and understanding the private equities’ current market dynamics.
Conclusion
Liquidity differences in public and private markets can lead to different return dynamics over shorter horizons. As the horizon extends, correlations among listed and private equities increase, reflecting the fact that they are both equity positions and thus share similar exposure. Marrying this with the longer-term investment horizon of private equity participants, it stands to reason that using longer-term correlation relationships is more suitable for asset allocation decisions.
