Is the illiquidity
premium dead?
BROUGHT TO YOU BY THE MULTI-ASSET SOLUTIONS TEAMNOVEMBER 2021

Executive summaryn Each quarter, we survey managers across the New York Life Investments

platform to gather views, identify priority themes, and pressure-test
investment ideas.
n The rapid return of abundant liquidity and high valuations in private markets

has been a focus for our U.S. managers. Despite the likelihood of modestly
rising interest rates in the coming years, factors driving demand for private
asset classes are likely to endure, raising concerns about future sourcesof return.
n The story is slightly different in Europe where decentralization, geographic

fragmentation, and a still-maturing market provide ample opportunity toharvest an illiquidity premium, particularly in the mid- and lower-mid market.
n While the illiquidity premium may be durably lower in some markets in years

ahead, the business risk premium for investors is alive and well.
n This piece examines how the oft-cited “search for yield” is playing out in a

new economic cycle, how managers are adapting, and priorities for excellingin a highly competitive market.

1

Pandemic disruption short-lived, search for yield persists“Search for yield” was a common refrain in the wake of the 2008 financial crisis.
Record-low interest rates and sluggish growth prompted a large and consistentflow of capital to higher-yielding asset classes, including private markets.

The search for yield continues
Persistently lower bond yields...
Global markets bond value by yield ranges...have led to a consistent uptrend in fundraising
Private capital fundraising activity, $B

100%
2,855
2,819
2,673
2,618
2,895
2,780

2,050
1,869

1,846
1,782
1,593

60%

1,813

1,665
1,443

40%

1,322

20%

Sub-zero

12/2001
0-1%

1-2%

12/2006
2-3%

12/2011
3-4%

4-5%

12/20165-10%

5/2021
Over 10%Sources: New York Life Investments Multi-Asset Solutions, Bloomberg Finance
LP, PitchBook, 6/30/21. Past performance is no guarantee of future results.

$897.2$1,118.4$1,066.3$1,000.2$874.2$794.6$775.9$625.1$509.3$409.4$363.3$395.6$712.4$798.2$576.20%
12/1996468$259.3

Bond Value80%’06 ’07 ’08 ’09 ’10 ’11 ’12 ’13 ’14 ’15 ’16 ’17 ’18 ’19 ’20 ’21*
Capital raised ($B)

Fund count*as of March 31

Sources: New York Life Investments Multi-Asset Solutions, Bloomberg
Finance LP, PitchBook, 6/30/21. The COVID-19 pandemic impacted
fundraising in 2020. As a result, 2020 fundraising volumes may not be
indicative of a reversal in the fundraising uptrend.

Abundant liquidity increases opportunities, but also exacerbates competitive
challenges. Even before the pandemic, pressure to put money to work led toincreasing valuations across asset classes. High valuations reduced return
potential and encouraged investors to take on more leverage and invest inlower-quality companies.
All the while, investors feared that a disruption to liquidity would bring a “reckoning”
to risky investor behavior.
The COVID-19 pandemic appeared to be that reckoning, at least for a time. But swift
monetary and fiscal support helped to stabilize the corporate environment. Company
defaults, while numerous, were far below financial-crisis levels. Expectations forcorporate defaults have all but moved into the rear-view mirror.

2

PAUL BEHARNEW YORK LIFE REALESTATE INVESTORS(Real estate)

The Global Financial Crisis acted as a receding tide that lowered all boats,regardless of asset class, sector, or geography. The COVID-19 pandemic prompteda very different dynamic; a sectorial and geographic bifurcation. Still, demand for
quality assets in favored sectors is elevated and is resulting in fierce competition
leading to compressed yields. Adding value requires anticipating future trends
and making smart moves where we have a high level of conviction. In real estate,anticipating demographic trends, including migratory patterns, has always been
important. The pandemic has accelerated some of those trends, to the benefit ofthose investors already positioned to capture that upside.

Portfolio managers’ survey shows improved perspective on default rates
Market data supports managers’ perspective

What do you expect for default rates during this cycle?
In Q2 2020, expectations were
for a somewhat protracted
default cycle, although not
as bad as during the global
financial crisis (GFC).

By Q2 2021, those expectations
had improved measurably, withmost expecting a significantly
better scenario for companies
relative to the GFC.

0100
Mean 58 Median 60

Median 87 Mean 89

Significantly
worse than GFC

Significantly
better than GFC

Default rates
16%

12%

8%

4%

0%
2006

2007

2008

2009

2010

2011

2012

2013

U.S. Loans

2014

2015

2016

2017

2018

2019

2020

2021

U.S. Bonds

Sources: New York Life Investments Multi-Asset Solutions, Quarterly boutique survey, Q2 2021, conducted June 1– June 7, 2021.
Bloomberg LP, 6/23/21.

3This dynamic has led investors to wonder: If the pandemic and corresponding
zero-revenue environment couldn’t shake up the scale of liquidity in private markets,
what can? And if an abundance of available capital keeps valuations at record levels,
can investors still capture the incremental yield they seek in private markets anyway?
If not, why accept the longer lockup period?
In other words: Is the illiquidity premium dead?
Prudent investors will tell you that just when you start wondering whether market
discipline will return, it tends to surprise you. While expansionary periods tend to beconstructive for both underlying economic growth and liquidity, it is important not
to become too complacent. Both cyclical and structural factors could result in adamaging liquidity shock.

What could result in a liquidity shock?
Black swan:1 An unexpected economic or geopolitical shock resultsin deterioration in economic (credit) and market (liquidity) conditions.
Fiscal and monetary support may prove insufficient in maintaining
orderly capital market functioning.
Higher interest rates: Stronger trend growth and higher inflation raiseinterest rates, potentially reducing attractiveness relative to public asset
classes. For this to occur, we would need to see:nStronger trend growth: Sustained stronger productivity and labor
force participation contribute to higher long-term economic growth
rates, resulting in a higher cost of capital.

nStronger inflation: If “transitory” inflationary pressures prove durable,higher policy and market interest rates would follow.

nReceding international demand: The “search for yield” is not adomestic phenomenon; global appetite for U.S. assets contributes
to lower market interest rates. Its abatement, whether due to theemergence of relatively more attractive stores of value or due toreduced trust in U.S. policy stability, could weaken or reversethat effect.

Market structure: A regulatory, capital, or competitive dynamic
reduces the attractiveness of private assets relative to public asset
classes. Investors are left without options.

1. A black swan is an unpredictable event that is beyond what is normally expected of a situation and has potentially severe consequences.
Black swan events are characterized by their extreme rarity, severe impact, and the widespread insistence they were obvious in hindsight.
4

Careful navigation of these risks is important to adding value to the multi-year lockup
periods that private market investments require. But few investors consider theserisks urgent, and many believe that demand can sustain a liquidity shock. The
low-yield post-financial crisis environment pushed many investors to assess anddevelop comfort in private asset classes. Greater comfort with these higher-yielding
asset classes makes a flight to public markets unlikely.

Private asset classes were less utilized before the Global Financial Crisis, in part
because their risk factors and levers of value-add were less known. The global
search for yield prompted more investors to consider and develop fluency inprivate asset spaces. This comfort may make it less likely that capital dedicated
JENN COTTONMADISON CAPITALFUNDING(Private credit)

to the space evaporates. Alternative asset classes are often actively managed
and offer unique attributes compared to other asset classes.

Additional flexibility in some private markets, such as private equity, may also mitigate
the risk of capital outflows from the space. Investors have created ways to break fromtraditional structures for those who need faster liquidity, or, by contrast, who want tohold strong businesses with attractive prospects for growth longer than their initialhold period. These innovations in funding have created additional comfort with theasset class and may contribute to its buoyancy.

5Beyond the illiquidity premiumWith demand for private assets posed to persist, investors have to consider othersources of value creation. Just as declines in the risk-free rate have driven investors
to assets benefiting from an illiquidity premium, a declining illiquidity premium means
investors must leverage other sources of return.

The building blocks of investor return
Investor return

Market characteristic

Market characteristic

Market characteristic

Manager’s skill

Risk-free rate

Equity risk premium

Illiquidity premium

Business risk premium

Investor’s expected returnfrom a risk-free asset
over a period of time,often represented by
U.S. Treasury yields.

Excess return earned byan investor when they
invest in the stock market
over a risk-free rate.
This return compensates
investors for taking
on the higher risk ofequity investing.

Additional compensation
required to encourage
investment in assets thatcannot be easily andefficiently converted into
cash at fair market value.

Return generated bytaking on the uncertainty
of a company’s future
cash flows, which areaffected by the operationsof the company, its
capital structure, andthe environment in which
it operates.

Opinions of New York Life Investments Multi-Asset Solutions.

CHRIS STRINGER
PA CAPITAL(Private equity)

When making an investment, we consider all the building blocks of return.
The risk-free rate, equity risk premium, and now even the illiquidity premium
have declined amid persistently low interest rates and a global search for yield.
However, investors’ value-add need not be tied to these factors, which areoutside of our control. There is ample opportunity to generate returns where
investors can access innovation or an active business-building approach —opportunities that aren’t available in public markets.

6Generating business risk premium as valuations climb
Given the flood of capital to private markets, managers have record dry powder. This
cash is being invested at record valuations, which creates challenges and increases
competition for investment teams. Private markets managers are often “buy and hold”
investors, with lockup periods of anywhere from 3-12 years; a lot can happen in theeconomic environment and capital markets during that period, reducing investors’
margin for error.

Record dry powder is unlikely to go anywhere fast
Private debt capital overhang ($B)

$1,400$350$1,200$300$1,000

$250

$800

$600

$400

Overhang by vintage

Overhang by vintage

Capital overhang

Private equity capital overhang ($B)

$200

$150

$100

$200

$50

$0

$0
’06 ’07 ’08 ’09 ’10 ’11 ’12 ’13 ’14 ’15 ’16 ’17 ’18 ’19 ’20

Cumulative

2013

2014

2015

’06 ’07 ’08 ’09 ’10 ’11 ’12 ’13 ’14 ’15 ’16 ’17 ’18 ’19 ’20
2016

2017

2018

2019

2020

Source: New York Life Investments Multi-Asset Solutions, PitchBook Q1 2021 Private Fund Strategies, 9/30/20.

As a result, a manager’s investment thesis needs to factor in not only broader capital
markets considerations but specifically the value creation options for the business,
including — but not limited to — what can be done to pivot if the macroeconomic
cycle turns.

7

At the same time, investors in some markets face a dearth of alternatives. If the
only way to capture additional yield is to lever up positions or move lower in quality,
those positions require more rigorous due diligence.
Credit evaluation is still key. In debt products, protecting principal and generating
income are primary goals. The return profile for investors is asymmetric: Upside
potential is capped, while downside could mean a default scenario. The ability
to evaluate credit can add significant value in periods of vulnerability. And whilequantitative analysis is a vital component of this process, qualitative analysis —including an understanding of market dynamics and the borrower’s levers ofvalue creation — is just as important.
Know what to avoid. Modeling downside scenarios is a bit of art. Managers withlong histories and deep knowledge of the market can refer to how similar businessmodels have reacted during different crises. This experience is valuable not only inmanager selection, but also within teams as they react to unforeseen challenges.
Find a durable capital base. Investors backed by a long-term, persistent capitalbase can leverage two benefits during various market periods: (i) opportunisticallypurchase well-priced assets in macroeconomic downturns and provide flexible,
durable partnership to select borrowers facing near-term constraints, and (ii) more
readily invest when tailwinds are strong and debt issuers have their choice ofcapital providers.
A long-standing approach to the market can also help in sourcing the best
opportunities over time. In order to turn down unattractive deals, investors must havea strong pipeline that allows them to be selective. This takes time and infrastructure,
which aren’t always available for new entrants.

ARON DAVIDOWITZPRIVATE CAPITALINVESTORS(Private placements)

Market dynamics being what they are, investors can’t simply deploy dollars
in private assets. They need to have access to the best deals from trusted
partners. Relationships are about more than just doing deals. Proving thatyou can act as a counterparty of choice, capable of writing a large check,and likely to be there for future add-on deals or refinancing — across various
market cycles — that’s how investors source the best opportunities in today’senvironment and create mutual value for investors and issuers.

Don’t race to the bottom. With so much cash chasing deals, new market entry
results in higher prices, elevated leverage levels, and weaker covenants—potentiallylowering returns or elevating risk. Relying on good management teams with strong
relationships and multiple levers of value creation can win hard-to-access deals
without sacrificing covenants.

8

Cutting costs isn’t the only way. A common concern about private equity isthat managers cut costs to generate value. While this is one important lever ofvalue creation, focusing on business growth may be a more sustainable approach.
Investing in talent and operational excellence can be a stronger path to scaling
cash flow. Working with borrowers on terms that allow them to adapt and grow
may also add value.
Consider the mid- and lower-mid market. Pulling on those different leversof value is not always straightforward; that’s part of the logic behind an illiquidity
premium in the first place. In some markets, investors can trade in and out of deals
and loans more quickly. For others, assessing opportunities, selecting managers,
and evaluating solid borrowers can take years of infrastructure creation. This highly
manufactured value-add can generate higher or more durable returns, but it’s notavailable everywhere. In private debt, and private equity in particular, we consider
the middle market to provide a stronger source of potential value-add.
Leverage a repeatable playbook. Both the Global Financial Crisis and the
COVID-19 pandemic were highly unusual economic cycles with vastly different
consequences. The next cycle will look different, too. The complexities of private
capital give investment teams more opportunities to create value. How do you know
if a buyer is capable of that? You can only do it by looking at the manager’s history.
Managers with a proven, repeatable playbook, tested across multiple market cycles
and strong market reputation, are more likely to weather the next storm.

Different cycles, different funding environments
Private Capital Fund Size ($M)$700

GlobalFinancial
Crisis$600

COVID-19
Pandemic

$500
$400
$300
$200
$100
$0
2006

2007

2008

Top quartile

2009

2010

2011

Median

2012

2013

2014

2015

Bottom quartile

2016

2017

Average

2018

2019

2020

2021

Global recessions

Source: New York Life Investments Multi-Asset Solutions, PitchBook Q1 2021 Private Fund Strategies, 3/31/21.

9

Diversify by geography. Not all markets are created equal, particularly for private
credit. The U.S. is large, mature, and fairly homogenous in structure, making
concepts discussed in this paper, such as the business risk premium and the middle
market opportunity, particularly valuable for yield-seeking investors. The European
market, by contrast, is more fluid — growing, maturing, and expanding where its U.S.
peers are more rigid. It is also more fragmented, with documentation, origination
strategy, and banking structure varying by country. This creates an opportunity for
private credit partners who can navigate a decentralized region, offering distinct
advantages to investors, including the ability to harvest an illiquidity premium.

JAIME PRIETOKARTESIA(European private credit)

Harvesting an illiquidity premium has become more demanding for private
U.S. investors, who instead must rely on trusted partnerships, businessbuilding, and careful credit selection to add value across market cycles.
These same tools are valuable to success in European private credit as well.
However, the European lower-mid market offers additional opportunities
to private credit investors relative to the U.S. Leveraging disciplined andconsistent positioning across European countries can result in better riskadjusted returns. The adage that investors must take higher risk to generatehigher return may not be true in this case.

Consider cross-asset relationships. Some asset classes, such as private
debt and private equity, are deeply intertwined. This link may result in correlatedrisks: Distress in one asset class can impact another. However, it can also create
coordinated levers of value. Leveraging general partner (GP) relationships acrossasset classes could generate new opportunities.

10What’s next?
There are always uncertainties in the investment environment, but they may be
more pronounced after the COVID-19 pandemic. It’s not difficult to consider how
financial conditions could tighten, but ample policy support and available capitalmake it tempting to join the trends towards higher leverage, weaker covenants,
and higher risk.
Instead, investors can leverage true business acumen to add value. While there
may be debate about the persistence of the illiquidity premium, the business risk
premium is alive and well.
All the while, the macro backdrop for private assets is strong. We expect robust
growth, moderate inflation, and improving credit fundamentals in the coming
years — all constructive for private investment. Low global yields likely mean thatthe “search for yield” is here to stay, which means flows to private assets arelikely to continue.
But performance dispersion of private capital firms is wide. When testing new
waters, it is essential to work with managers who have sailed in rougher seas.

11

Definitions
Alternative asset classes typically refer to investments thatfall outside of the traditional asset classes commonly accessedby most investors, such as stocks, bonds, or cash investments.
Dry powder refers to cash or marketable securities that are
low-risk and highly liquid and convertible to cash.
Environmental, Social, and Governance (ESG) refers to
the three central factors in measuring the sustainability andsocietal impact of an investment in a company or business.
Excess return is the return of a portfolio in excess of its
benchmark where in excess is calculated geometricallyby subtracting the benchmark’s return from the portfolio’s
return in each period.
A general partner (GP) refers to the private equity firm
responsible for managing a private equity fund. The private
equity firm acts as a GP, and the external investors are LPs.
The investors who have invested in the fund would be known
as Limited Partners (LP), and the PE firm would be known
as General Partner (GP).

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IMPORTANT DISCLOSURESThe Multi-Asset Solutions team is a part of New York Life Investment Management LLC, an indirect wholly owned subsidiary of New York Life Insurance Company.
Real Estate Investors is an investment division within NYL Investors, a wholly owned subsidiary of New York Life Insurance Company and an affiliate of New YorkLife Investments. Madison Capital Funding is a wholly owned subsidiary of New York Life and its subsidiary, New York Life Insurance and Annuity Corporation(“NYLIAC”). PA Capital LLC is a registered investment advisor under the U.S. Investment Advisors Act of 1940 as a relying advisor of New York Life Investments
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select securities, which could result in relative investment performance deviating from other strategies or broad market benchmarks, depending on whether
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