In focus - Markets

Investors’ great expectations: Can private assets deliver against high hopes?

Investors are asking a lot from private assets as traditional asset classes look stretched. We find out if they can deliver.

26/09/2019

Andrew Lacey

Andrew Lacey

Investment Writer

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CPD Accredited

Institutional investors have grown increasingly cautious over the past three years but continue to expect strong market returns, according to new Schroders research. Many believe private assets will be crucial to sustaining performance in a tougher environment for traditional assets.

A change of approach

Schroders’ Institutional Investor Study asks institutional investors around the world about their attitudes and priorities. Surveying 650 influential investors from 15 different countries – who together manage some $10.8 trillion in assets – the study gives a valuable insight into their investment objectives, concerns and priorities.

Over the past three years, the survey has shown that concerns over slowing economic growth and destabilising political and world events has risen. Consequently, investors are reducing their allocations to traditionally risky areas of the market like developed or emerging market equities. Anticipated returns, meanwhile, have not noticeably fallen. Most investors remain confident that they can still deliver between 5-9% annual total returns (or more).

But how will investors replace lower equity allocations?

Yields on major government bonds remain very low, given sustained or increasing slack in global central bank policy. Even the Federal Reserve – after a short tightening cycle – has latterly been more dovish. Schroders’ long-term return forecasts are for annual nominal returns of 3.6%, 3.1% and 2.5% for US, UK and euro sovereign bonds, respectively.

The same forecasts project annual nominal returns of around 4.7% for US investment grade (IG) corporate bonds over the next 30-years, 3.0% for euro IG and 3.9% for sterling IG. Only US high yield, with the highest projected nominal return in the fixed income universe, is in the target return range with expected annual returns of 5.8%.

How does the equation balance?

The survey suggests that most investors accept that achieving stable returns will mean conventional approaches need to change. Of the investors we approached 71% said their organisation would be happy to adopt new financial instruments or asset classes.

This means that allocations to private assets are expected to rise. Meanwhile, expected average holding periods are higher than last year, which tallies both with higher anticipated short-term volatility and the lower liquidity in private assets.

Great expectations

Institutions point to the need to generate higher returns (74%) and diversify portfolios (73%) as the primary reasons for using private assets. Investors in North America (89%) attach significantly more value to the prospect of generating higher returns, while diversification (85%) is a stronger driver for investors in Asia.

The question then arises as to whether the asset class can deliver. Respondents mostly believe that private equity will deliver in excess of 5% over the next 12 months, and in doing so, will be the strongest area of private assets. Expectations are comparable for infrastructure equity.

Return expectations highest for private equity

PA_current_allocation_ret_exp

Source: Schroders, Institutional Investor Study 2019. The forecasts included should not be relied upon, are not guaranteed and are provided only as at the date of issue. Our forecasts are based on our own assumptions which may change. We accept no responsibility for any errors of fact or opinion and assume no obligation to provide you with any changes to our assumptions or forecasts. Forecasts and assumptions may be affected by external economic or other factors.

Tim Boole, Head of Product Management for Schroder Adveq discusses why investors are optimistic that private assets, and private equity in particular, can help.

“Over the past 25 years, private equity has outperformed public equity by 3% per year, on average.

"There are a number of factors driving this, but one is the illiquidity premium.

"Institutional investors are increasingly acknowledging that as long-term investors they have been needlessly paying (in the form of lower returns) to have access to liquidity that they weren’t using.

"So part of the attraction of investing in private assets is to capture that higher return.

"Private assets is also a far broader universe, and growing especially in private equity where companies are choosing to remain privately owned.

"Investors can diversify their portfolios and access segments unavailable via public markets such as early stage venture capital or small and medium sized companies; too small to justify the overheads of being listed.

"In the past these companies had few means to access new capital and it came at a high price.

"The growth of private equity has given those companies more options and on the flip side investors are able to access investment returns previously captured by corporates making strategic acquisitions.”

Finding the right guide

Of course, increasing an allocation to private assets is comparatively complex. Institutions still point to a number of hurdles - fees, liquidity issues and complexity are the main challenges - when investing in private assets.

Yet institutions are also aware that the attractive premiums offered by private assets are a function of the illiquidity and complexity factors. As a result, most are willing to outsource the expertise required to overcome these challenge.