Private markets: the quest for diversification

Institutional investors have long thought of private markets as a way to boost returns. But the recent challenging economic conditions have further enhanced the role that private market investments can play in portfolios. In particular, investors are now relying on private markets to help diversify their portfolios. This shift reflects two trends. Firstly, a greater correlation between public debt and equities. And, secondly, a growing awareness of the opportunity to diversify within private markets.

Institutional investors also remain aware of the importance of portfolio liquidity. Their ability to meet cashflow needs for benefit payments, rebalancing or other capital obligations is vital. A growing private market has eased this concern as there are more players looking to buy, sell, or trade at any given time.

A spotlight on private markets

Private markets used to be a dark and opaque space for investors. But it’s now emerging as a big landscape of opportunities that includes real estate, infrastructure, natural resources, private equity and private credit. Investors had started exploring these areas over the past decade, but that trend has accelerated during the pandemic.

The new interest is emerging against the backdrop of growing venture capital. The cost of building and running a company has become much cheaper in recent years. Technology giants such as Alibaba, Snapchat and Facebook have had multi-billion dollar initial public offerings. And it’s clear that there’s a massive opportunity to create value in private hands before companies even reach the public markets.

Opportunities exist at various levels. The private market caters for investors looking to buy into riskier start-ups, as well as those who want to hold more mature private companies. Even before the pandemic, private companies were staying private for longer. This trend is unlikely to change in the current environment.

Private income

There’s been an influx of high-quality infrastructure projects, which investors would previously have funded via government bonds. But now private funding has blossomed to cover opportunities to invest in schools, hospitals, roads and other projects that are essential to local economies.

Private income investments have also expanded as capital-constrained banks have pulled back on lending. This followed a spate of regulations in response to the global financial crisis of 2008-2010. Investors used to think of private markets as just private equity, but there is now a vast and growing private capital debt market.

Diverse opportunities

The global economic challenges of 2020 have created further opportunities for private-market investors.

The global economic challenges of 2020 have created further opportunities for private-market investors. This is particularly the case for real estate and supply chains, which have experienced pandemic-related disruption. For example, the growth of e-commerce has affected logistics and retail markets. There are also new opportunities in technology, such as systems that have enhanced working-from-home productivity and allowed for the delivery of virtual education and healthcare.

Over the longer term, we are going to see more remote working that spans a whole range of industries. What does that mean for real estate in terms of how people manage space? And what does it mean for residential property and how people live, work and play? We think these changes will create opportunities in real estate and in private equity. There will also be opportunities in terms of how we finance some of these transactions.

A focus on sustainability

Private markets provide an opportunity for investors to focus on environmental, social and governance (ESG) factors within their portfolios. ESG investments can also help investors who are looking to use their capital in a more effective way. As direct owners of a private investment, investors have more say over environmental policies and stakeholder management. As such, ESG becomes more embedded in the business. We can make operational changes regarding a company’s environmental footprint, diversity and social aspects. We can also look at the supply chain more carefully and ensure companies pay living wages.

There’s a growing recognition that if investors minimize ESG factors today, it will only create material issues later. This can create regulatory scrutiny or reputational risk. Private companies that are as transparent as possible about their ESG process will have an advantage. This is particularly the case when it comes to raising capital and growing value for investors.

Balancing the portfolio

Despite how private markets have evolved recently, many institutional investors are still underweight in the asset class, mainly due to implementation issues. They often have low or no exposure to private equity or infrastructure, or they might lack either the debt or equity side. Since assets can’t be priced and traded overnight, investors need lawyers, accountants and finance experts that understand the assets and the complexity around them.

Investors are now rethinking how they can generate returns and meet their objectives. The vast and varied scope of private markets may provide part of the answer.

A version of this article was first published on Pensions & Investments Online on November 30, 2020.

 

IMPORTANT INFORMATION

Fixed income securities are subject to certain risks including, but not limited to: interest rate (changes in interest rates may cause a decline in the market value of an investment), credit (changes in the financial condition of the issuer, borrower, counterparty, or underlying collateral), prepayment (debt issuers may repay or refinance their loans or obligations earlier than anticipated), call (some bonds allow the issuer to call a bond for redemption before it matures), and extension (principal repayments may not occur as quickly as anticipated, causing the expected maturity of a security to increase).

Among the risks presented by private equity investing are substantial commitment requirements, credit risk, lack of liquidity, fees associated with investing, lack of control over investments and or governance, investment risks, leverage and tax considerations. Private equity investments can also be affected by environmental conditions / events, political and economic developments, taxes and other government regulations.

Companies mentioned for illustrative purposes only and should not be taken as a recommendation to buy or sell any security. It should not be assumed that recommendations made in the future will be profitable or will equal the performance of the securities in this list.

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RISK WARNING

The value of investments, and the income from them, can go down as well as up and you may get back less than the amount invested.

Unless otherwise indicated, currency is stated in USD.