February 22, 2024
Marketing Director
Continuing our series of interviews to gain better insights into private markets, we sat down with Sergey Aslanyan who works for Klimfo, a single-family office based in Switzerland.
About a year and a half ago, Klimfo began shifting a portion of its portfolio allocation from public to private markets, adopting private equity and venture capital strategies. I am responsible for analysing the performance and risk associated with the private markets. This includes verifying the often-praised outperformance of private equity to ensure it truly exists. My role involves sourcing and selecting funds that align with the Family Office’s objectives.
Indeed, the private debt market continues to grow rapidly. According to Pitchbook, private debt AuM crossed the $1.5 trillion mark in 2023, tripling in size over last decade. There are concerns about a potential bubble due to the fast-paced growth of the private debt market. Certain sub-strategies of Private Debt, such as distressed debt or mezzanine financing, may exhibit higher default rates compared to others like senior debt or direct lending. However, in the grand scheme of things, the private debt market is still much smaller and younger compared to other asset classes or even other private market strategies such as Private Equity.
Family offices and other investors can take advantage of the rapidly growing private debt market in several ways. Private credit investments have historically generated substantial excess return, adjusted for risk. Especially in a high interest rates environment since many, for instance, direct lending notes have floating rates with an underlying such as SOFR. Despite the first interest rates cuts expected in 2024 and 2025, most macro forecasts assume elevated rates in the next years. Private debt can also provide a good source of diversification for an investment portfolio and reduce the equity driven volatility.
However, it’s important to note that investing in private debt also comes with its own set of risks, including liquidity risk, regulatory risk, and default risk. Therefore, careful due diligence and risk assessment are crucial.
The democratization or ‘retailization’ of private equity markets aims to make investment opportunities more accessible to a broader range of investors, including non-professional retail investors. Lower minimum investment amounts (starting from $25k), ‘Evergreen’ or open-ended funds, often referred to as ‘semi-liquid’ funds, increased transparency with more detailed reporting and disclosure requirements, rise of technology platforms which allow retail investors to access private market investments, changes in regulations that paved the way for creation of new fund structures that are subject to more rigorous control - these examples illustrate how private market is becoming more accessible to a wider range of investors.
However, this process comes with several challenges and risks. Currently, interactions in private equity are governed by agreements rather than strict regulations. As democratization occurs, average investors may lack understanding of market mechanics and terms, potentially putting their investments at risk. This could prompt the politics to enact stricter regulations to protect retail investors. As a result, increased compliance will become more difficult and expensive with more investors. Furthermore, with more participants, market volatility may rise, posing higher risks for investors. And, of course, the liquidity risk remains. This could pose a challenge for retail investors who may need to access their funds on short notice and are not familiar with the inherent characteristics of private markets, particularly illiquidity.
In our fund selection process at Klimfo, we have incorporated the use of qashqade SaaS platform for calculating the waterfalls of various funds. With the support of qashqade, we have been able to model different scenarios to compare management and performance fees effectively. We have utilized various management fee rates (with different bases), different hurdles, NAV dynamics, carry, and other parameters in our models. The ability to manipulate these variables has provided us with a comprehensive understanding of each fund’s potential costs.
From our point of view, qashqade’s strength lies in its capacity for automated computation of different waterfalls. It is significantly faster and more precise than traditional methods such as using Excel sheets. This efficiency not only saves us valuable modelling time but also ensures the accuracy of our results, giving us confidence in our decision-making process. The adoption of qashqade has greatly enhanced our fund selection process, enabling us to make informed decisions based on reliable and error-free computations.
Limited Partnership Agreements (LPAs) are crucial for computing different waterfall models and scenarios. Understanding the corresponding LPAs is essential, especially since the misinterpretation of main terms and conditions can bear costly consequences for an investor. LPAs are often written in a complicated manner, unclear, and require interpretations. This complexity can pose challenges for an average investor who may not find it easy to decipher the terms and conditions.
The qashqade LPA validation feature is very valuable tool in this regard. It has significantly aided in understanding the terms and conditions of LPAs and formed the basis for setting up waterfalls and calculating different scenarios. One of the key benefits of qashqade’s LPA validation is its ability to address misallocations of fees. These could include “broken deals”, GP-led provisions, and the compounding method for hurdle calculations. qashqade’s LPA validation is a valuable service that simplifies the complex task of understanding LPAs, thereby enabling investors to make informed decisions.
