Allocating to private assets: an essential guide
We explain the role private assets can play in portfolios, the key considerations before investing, and the options available to investors.
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Key Takeaways
- New products, regulations, and technology have expanded private market access.
- Private markets can diversify and enhance a traditional 60/40 portfolio.
- Private assets can improve risk-return ratios, meeting specific investor goals. We demonstrate how.
- Private market investment requires long-term dedication, thorough research, and risk understanding.
- Open-ended evergreen funds: an appealing option for private market newcomers.
As private markets become more accessible, private investors are increasingly considering shifting parts of their portfolio to this space. While this trend accelerates, private investors remain under allocated compared to their institutional counterparts.
Our research indicates that globally institutional investors had allocated, on average, 14% of their portfolio to private assets1. In comparison, typical clients’ allocation to private assets for most financial advisers and wealth managers globally ranges between 5% to less than 10%2. For 30% of wealth managers we surveyed the allocation to private asset investments is even lower, at 1% to less than 5%.
There are different ways private clients can incorporate private assets into a traditional portfolio to achieve their goals. What portion of the portfolio to invest in these assets, how much to allocate to each asset or what investment vehicle to choose are some of the biggest questions keen investors and their wealth managers are faced with today.
While our paper doesn’t provide advice on specific allocations, we've detailed essential factors for investors considering private markets, and the potential implications of such an allocation for their portfolios.
A changing landscape
The return and diversification opportunities private assets can bring are well known among long-term institutional investors. We have recently analysed this in more detail.
However, private investors have had limited options to access this space. Regulatory developments, technology-driven platforms, new fund structures specific for private investors are reducing these hurdles.
60/40 portfolio being challenged
The traditional 60/40 portfolio has been challenged over recent years due to increasing correlation between stocks and bonds. Rising inflation and interest rates have increased costs and put pressure on equities, while also raising the cost of capital and impacting stock markets. For bonds, high inflation and surging rates have eroded fixed cash flows and affected prices. Future trends like increased debt, deglobalisation, demographic changes, and disruptions in technology and energy security could heighten these challenges.
Private assets could play a critical role in addressing present and future challenges and adapting to the evolving market structure, offering potential to boost capital growth, enhance income generation, and provide capital preservation. Additionally, private markets can provide diversification benefits to portfolios, helping to mitigate some of the risks associated with traditional asset classes.
Incorporating private assets into a portfolio
Private assets can play a strategic role in an investor's portfolio. The choice to include private assets should be carefully considered, taking into account the investor's risk tolerance, investment time horizons, and the potential impact on the overall portfolio. The private assets universe is diverse, and the specific assets selected should align with the portfolio's objectives.
These assets can offer a 'complexity premium', potentially yielding higher returns compared to public market equivalents, due to their ability to navigate complex investment situations. Furthermore, the less efficient nature of private markets can create opportunities for skilled investors to uncover undervalued assets.
The diversification benefits of private assets can help mitigate portfolio volatility, and historically, they have demonstrated favourable risk-return profiles.
Risk return profiles for public and private asset classes (de-smoothed for private assets)
Meeting specific investment objectives
When allocating a portion of an investment portfolio to private assets, one should consider the size of the portfolio, the risk tolerance and time horizon of the investor, alongside their liquidity and income requirements. The potential benefits of allocating to private markets can be visualised by plotting the risk and return for different combinations of portfolios; constructing an ‘efficient frontier’.
Potential outcomes when incorporating private assets in a global 60/40 portfolio
The efficient frontier for a portfolio that includes private assets within a traditional global public assets' portfolio is higher than that of one without private assets. This indicates that, for the same level of risk, a portfolio with the diversification benefits of private assets can potentially generate higher returns than a portfolio without private assets.
Note: The triangle-like shape shows the perimeter of possible portfolios when adding a maximum of 20% of Private Asset to the 60/40 Portfolio, shaded by the Sharpe ratio with a 0% risk-free rate. The top side is the well-known efficient frontier, whereas the other two sides close the perimeter of possible portfolios, also known as inefficient frontiers in some contexts.
Incorporating private assets into a multi-asset portfolio can enhance risk-return trade-offs and cater to specific investor objectives such as growth, income generation, capital preservation, and inflation protection. It can reduce overall portfolio volatility, enhance returns and provide diversification benefits.
For a growth portfolio, a slight increase in risk can yield notable returns. An income portfolio, despite slightly lower returns, can benefit from liquidity and income generation. Moreover, optimising a global 60/40 portfolio with a higher private asset allocation of up to 20% can further improve the risk and return profile, as demonstrated by the efficient frontier. This allocation can range from private equity to infrastructure equity, with pro-rata adjustments to debt/equity allocations.
Key considerations when investing in private markets
Private markets are inherently less liquid than public markets and locking up funds for a significant period is unfamiliar to many private investors. Liquidity risks must be understood and managed from the outset, like any other investment risk.
Private markets investments also require a long-term commitment and thorough due diligence on the underlying assets, the investment manager, and the specific fund structure.
The due diligence process can be complex and time-consuming compared to investing in publicly traded stocks or bonds. It is also crucial due to the absence of benchmark constraints. Unlike passive funds, which aim to match the performance of a specific market index, and active funds that seek to outperform a benchmark, private markets funds are not tied to any specific benchmark. This gives fund managers greater freedom to construct their portfolios and pursue investment strategies that align with their specific objectives. As a result, private markets funds have more bottom-up dispersion, meaning that the performance of individual investments within the fund can vary significantly.
New ways for private clients to access private markets
Incorporating private market investments into multi-asset private wealth portfolios needs a strategic approach.
There are different routes wealth businesses have been taking to allocate to private markets, based on their clients’ needs and level of sophistication. For those investors who are just getting started in this space, new fund structures, particularly open-ended evergreen funds, are most appealing as they allow more flexibility in their investment plans, particularly in case of unforeseen circumstances. These funds could serve as an effective allocation tool complementing traditional closed-ended programmes, for example.
For those investors who want immediate access to liquidity, listed closed-ended funds could be beneficial. Many investors prefer this structure for the chance to profit from pricing discrepancies between share price and the Net Asset Value of the fund. However, it’s important to consider the potential liquidity mismatches in case of adverse market conditions.
Overall, private markets are increasingly growing their footprint in the global capital markets. This carries significant implications for future portfolio construction, especially for wealth clients, which have historically underweighted this space compared to their institutional counterpart. The availability of more accessible investment products in the market is making this transition easier.
Read the full paper here
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New to private assets? Get started with our essential 101 resource
[1] Source: Schroders Institutional Investor Study 2022.
[2] Source: Schroders’ Global Investor Insights Survey questioned 1,755 wealth managers and financial advisers among other investor groups in 31 different locations across EMEA, UK, US, Asia Pacific, Latin America, between June and July 2024.
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