As investors continue to move money from public to private markets, some investment professionals are issuing a warning: Manage your expectations.
Since the advent of leveraged buyouts decades ago, investors have allocated more and more capital to private markets, earning outsized returns on their investments for a variety of reasons. Amid a downturn in public markets and a potential recession, rising inflation and geopolitical uncertainty, institutional investors are leaning even more toward their private market allocations.
But Nathan Shetty, head of Nuveen’s multi-asset team, warns that private equity and other illiquid assets are not a “cure or cure-all” for lower expected returns in public markets. Nuveen offers traditional and alternative investments, including fixed income, stocks, real estate and real assets. The manager has $1.1 trillion in assets, of which $80 billion is in private investments.
In an interview with Institutional investorShetty said institutional investors right now view private markets as a safety net against other market headwinds, namely increased risk and volatility, hitting their portfolios. This assumption stems from the higher-risk, higher-reward profile of the private market and the asset class’ “illiquidity premium” — the extra money investors theoretically get to lock up their capital and give up the ability to buy or sell. easily active. Private assets, which are valued quarterly rather than in real time like stocks, also look more stable, at least in the short term.
“I’m nervous that there’s going to be a mismatch in expectations between what institutions expect from private allocations and what private allocations can ultimately deliver arithmetically,” Shetty said. Me.
Investors often expect more than the market can realistically provide. Shetty said decades ago that the antidote to market turmoil was the hedge fund, which investors expected to generate double-digit returns that were also uncorrelated with other asset classes. But inflows and market forces changed the equation. During the 2000s, what is often called the golden age of hedge funds, these alternatives returned 6 percent annualized, even as the S&P 500 lost 1 percent over the decade. The hedge fund’s stellar performance record then attracted record inflows from investors who wanted to share in those gains. But through the 2010s, hedge funds only returned 4 percent a year, the result of all that cash plus a decade in which a simple portfolio of stocks and bonds returned 7 percent.
“It was an undue expectation and the hedge funds just couldn’t deliver on that,” Shetty said. “We don’t want to find ourselves in a situation where, if there is a mismatch in expectations, people question the efficacy or legitimacy of private markets in portfolios.”
Institutional investments in private markets are higher than ever, said Scott Gockowski, a senior manager at strategy consultancy Casey Quirk, which is part of Deloitte. Losses in public markets are partly to blame. At the end of the second quarter, institutions suffered significant losses in government securities, causing them to be overweight in their allocations to private markets. Here, the institutions had to make a choice: Do they sell some private investments on the secondary market to regain their footing, or leave their portfolios alone? According to Gockowski, most investors simply ran with their new allocations.
But Gockowski said it makes sense to question the future risk-return profile of private assets now that the sector has been awash with cash. “I think it will be interesting to see if the difference in private and public market performance persists,” Gockowski said. Me.
The data shows that investors are moving into private markets because they believe they will outperform public markets in the near future. In a CoreData Research survey of 130 European fund selectors in June 2022, 27 percent of respondents said their companies are shifting their investment focus from public to private markets; 31 percent said they believe private markets will consistently outperform public markets in the future.
Jeffery Diehl, managing partner and chief investment officer at Adams Street Partners, a private markets investment manager with more than $50 billion in assets under management, said most of his clients increased their asset allocation to private markets investments. or kept them stable in the past few years.
“I can’t think of one that’s really knocking it out,” Diehl said. Me. “The only reason someone might remove it is if they feel like it needs to become more liquid.”
Diehl said there is no question that the institutional investment community expects private markets to continue to outperform the broader market, a position he supports. The assumption that private markets will act as a Band-Aid for lower expected returns could stem from a few factors. One factor is the way private companies are governed: Owners have more control over operations and strategy than shareholders in a public company. Diehl argues that there is a greater alignment of interests between private business owners and upper-level management.
Diehl said another reason could be that the “innovator’s dilemma” is difficult to execute in a public company. This happens when companies see a change in the way their customers operate and invest in their operations or products to keep up. Public companies that pour more money into research and development or other initiatives to change direction need their shareholders to sit tight when their share prices fall in response to higher spending. But private companies don’t have to answer to a public stock market and innovation can happen at a faster rate, at least in theory. Private companies often have an advantage over their public peers, an attractive quality for investors looking to protect their portfolios.
But to avoid disappointment, managers need to be realistic with their investors.
“We try to manage people’s expectations, so I don’t get the feeling that anyone in our customer base is being too optimistic about things,” Diehl said.