Institutional investors have long thought of private markets primarily as a means to boost returns, but challenging economic conditions this year have many rethinking the role that private market investments can play in their portfolio.
In particular, they’re increasingly relying on private markets to enhance the diversification of their portfolios. This shift reflects two trends: a rise in correlated movement among public debt and equities; and a growing awareness of the opportunity to diversify within private markets. In addition, regulatory changes have cleared the way for some retail investors to enter the space through their 401(k) plans or other means.
“Private markets used to be this dark and opaque space, but it’s emerging as a big landscape that includes real estate, infrastructure, natural resources, private equity and private credit,” said Nalaka De Silva, head of private market solutions at Aberdeen Standard Investments. Investment into “private markets has become a broad spectrum of activity, including growth-oriented assets, such as venture capital and growth equity, and income-generating assets across real estate, infrastructure and natural resources.
“Investors had started exploring these things over the past decade, but in a COVID environment, those trends have really accelerated,” he said.
What’s more, this trend is emerging against the backdrop of a rapidly expanding venture capital arena, in which the cost of building and running a company has gotten much cheaper. With multibillion-dollar initial public offerings by tech giants like Alibaba, Snapchat and Facebook, it’s clear that there’s a massive opportunity for value creation in private hands before companies even reach the public markets.
That opportunity exists at various levels, allowing for investment from institutional investors looking to buy into riskier startups, as well as those who want to hold more mature companies. Even before the pandemic, private companies were staying private for longer, a trend that’s unlikely to change in the current environment, according to De Silva.
On the private income side, there’s been an influx of high-quality infrastructure projects that previously may have been funded via government bonds. As investment bankers had begun to securitize the infrastructure funding, the space has blossomed to a much larger opportunity set, allowing for private investment in schools, hospitals, roads and other projects essential to local economies.
“The only way to get exposure to those opportunities in the past was to buy municipal bonds, but the muni market is tightly priced and doesn’t offer much yield,” De Silva said. “This is another way to get the same type of exposure to government-backed, high-quality credit investments.”
The world of private income investments has also expanded as capital-constrained banks pulled back on some lending following a spate of regulations in response to the global financial crisis of 2008 to 2010. That allowed entry from other capital providers who could offer specialty financing, working capital for specific situations and turnaround capital for larger organizations.