Allocating private market assets in a multi-asset portfolio

Understanding how to allocate private markets in a multi-asset portfolio

The democratisation of private markets in recent years has allowed individual investors to invest in private assets. 

While long-term asset funds (LTAFs) are expected to offer a clearer framework for private markets investing in the UK, challenges remain around how well the assets that sit within the sector are understood and the availability of private market structures to drive investment.

Private market assets are typically accessed by investors via funds or investment trusts, offering them liquidity, diversification and fund manager oversight. 

They often form part of the alternatives allocation in a multi-asset portfolio where the multi-asset manager would firstly use a long-run strategic asset allocation to shape the exposures that are most likely to deliver the expected portfolio return, while remaining within risk constraints. 

So what are the best ways to allocate private market assets in a multi-asset portfolio?

Lindsay James, investment strategist at Quilter Investors, says: “A retail investor working with an adviser and making these allocations directly into collective investment schemes containing private assets would need to consider not only the impact the allocation could have on future portfolio returns, but also its contribution to volatility, management charges, and liquidity constraints, while also appraising the robustness of the investment process within the private asset fund and its overall suitability. 

“This is a tall order and so they tend to be used primarily by multi-asset managers who appreciate they can play a role in diversifying sources of return and in some cases, offering an element of inflation protection.”

At M&G, Adrian Gaspar, head of client portfolio management within the life business, says that with private market investment a hot topic for retail investors. Several large retail-facing investors have indicated they plan to increase their private asset allocation to benefit from attractive returns that are not impacted by periods of unexpected inflation risk, such as in 2022 when bonds and equity markets struggled.

Accessing private markets

Gaspar says the best way for retail investors to access private markets is by investing in a multi-asset fund with a high and diversified allocation to private assets.

He adds: “Currently, any solution that invests in a with-profits fund, either traditionally or through ‘smoothed’ products, may offer private market exposure to real estate and real assets. This is because insurance companies have a wider investible universe, which includes directly held property assets.

“The challenge for those looking to invest in private assets is that there are relatively few insurance-backed with-profits/smoothed solutions available, and alternatives are limited.

 “There does, however, appear to be a real sense of acknowledgment from both the government and the regulator of the importance of private markets and the benefits they could bring to the broader retail investor, as well as stimulating more investment in the UK.”

Gaspar points to the Mansion House compact and a recent Financial Conduct Authority paper discussing LTAFs as examples of this.

James Lowe, director – private markets at Schroders, says there are several ways that advised retail investors can allocate to private markets:

1. Invest directly via platforms in component parts, such as investment trusts, VCTs and/or LTAFs.
2. Through models or unitised multi-asset products that make allocations to private markets within their asset allocation. 
3. A less used area is through other structures such as limited partnerships or lux open-ended semi-liquid funds, now available via a number of UK platforms, but which require advisers to ‘opt-up’ their retail investors as they are only distributable to more sophisticated investors.

Investment trusts have a long history in the UK market, dating back to the 19th century. However, investment trusts specifically focused on private markets are a more recent development. 

They have gained popularity in the past 20 to 30 years as investors seek diversified exposure to private equity, private debt, and other private market assets. 

Baldric Todeschini, investment specialist – alternatives and multi-asset solutions at Abrdn, says: “Their shares are tradeable on the stock exchange, offering great liquidity to investors. Investors should nonetheless pay particular attention to the discount or premium they are paying versus the value of the underlying assets in the trust.

Todeschini says as well as investment trusts, evergreen structures are another way that retail investors can access private markets and diversify their portfolio beyond the traditional asset class.

He adds: “Evergreen structures are a more recent phenomenon. When we are talking about private markets pooled funds, they have been for too long the remits of large sophisticated institutional investors. 

“High minimum commitments and long-term investment horizons were the main hurdles for retail investors to access those funds. Evergreen structures are changing the dynamic by offering liquidity – typically quarterly – and lower minimum investments and democratising access to private markets.”

Knowledge requirement

Private markets are complex, global and straddle a vast array of different asset types.

M&G’s Gaspar says that after making available solutions that allow retail investors to allocate more to private markets, the next challenge is identifying those providers who have the experience, scale, resource, global footprint, and network of external contacts to build a best-in-breed private market solution.

Gaspar adds: “The opportunity set within private markets is vast and therefore requires large well-resourced teams, who have strong links across global private markets to source the best investment ideas.

“Competing for the best assets also requires scale and the ability to lock up capital for multiple years at a time. 

“Many private market investments are smaller companies requiring capital to grow, so investing tens of millions in these companies can make a significant difference, but to access major real estate and infrastructure projects directly could cost hundreds of millions of pounds and without significant scale this creates concentration and liquidity challenges.”

Liquidity challenges

Indeed, liquidity is often cited as a major challenge for retail-advised clients wanting to invest in private markets.

James at Quilter Investors says: “Many of the assets held in collective investment schemes are fundamentally illiquid, with relatively low price discovery due to a limited pool of transactions, most of which dry up entirely when there is market volatility.

“As a result, it can be difficult to appraise an accurate net asset value, meaning most investment trust of illiquid private assets will trade at a discount to NAV. Whether the discount is appropriate, let alone the reported NAV, can be a hotly contested debate. 

“While investment trusts can be traded in the market, offering good liquidity to retail investors, prices can be volatile.”

Understanding private market asset types

Private assets encompass an enormous range of asset types so it can be difficult to understand the investment drivers of each, the appropriate valuation and the likelihood of investment success.

James says: “While equity fund performance is generally correlated with the overall index and the stock selection process, the drivers of a venture capital fund, for example, are factors like the ability of the management team to source good opportunities that are likely to be more opaque and see a lot more variation between investment returns than choosing a US large-cap equity manager.”

Another challenge, according to James, is high interest rates, which can heavily impact valuations of some private assets such as infrastructure. 

She adds: “This is because it is valued as a strong of future cash flows discounted back to present day, and higher interest rates increase the discount rate. This factor has dominated the benefits of inflation protection in some recent periods.”

What private market assets offer

Investing across private markets require a long-term investment horizon and an appropriate level of knowledge.

When considering which of the private market assets work well in a multi-asset portfolio, it is important to recognise that each asset class has its own features.

Private equity, debt, real assets, infrastructure all have different characteristic and return drivers. Each asset class has sub-segments, which have their own specific nuances. 

As Todeschini explains, private equity offers strong potential for growth by investing in private companies or engaging in buyout of public companies, to increase their value.

Private credit delivers strong and stable risk-adjusted returns by lending money to private companies, infrastructure projects, real estate projects or other specialist areas, Todeschini adds.

Meanwhile, real assets (such as real estate, infrastructure and natural resources) offer a mixed yield, capital appreciation and downside protection by financing long-term and capital-intensive projects that provide essential services to society and the economy in a wide variety of sectors

Each asset also has its own risk profile.

Todeschini says: “That’s why at Abrdn we encourage investors to consider a diversified solution as a core building block of their private markets allocation and then build around it with more specialised funds. 

“We believe the diversification benefit will balance the risks as their allocation to private markets grow in a wider investment portfolio.”

Lowe says at a high level, the inclusion of private markets can help enhance returns and income and add diversification to investor portfolios. 

At Schroders the team generally considers four different outcomes that private markets can help investors with:

• ‘growth enhancement’: generally achieved by adding allocations to private equity, from both public equity and bonds;
• ‘income generation’: regarding allocation from equities to allocation focused on income generating assets such as private credit and real assets;
• ‘capital preservation’: taking an allocation from public equities and adding assets that reduce the portfolio’s overall volatility such as private credit and real assets; and
• ‘inflation protection’: generally moving from fixed rate public fixed income to focus on assets with inflation-linked cash flows such as floating rate private credit and income-generative real estate and infrastructure.

Shakhista Mukhamedova, head of global manager research Europe at wealth manager RBC Brewin Dolphin, says it is less about a specific sub-set of private markets and more about specific factors that would affect each type differently, adding it is her job to select the ones that she thinks are the best investment today based on broader views.

For example, private debt strategies can do well in a rising rate environment because they can re-invest in debt with higher coupons, whereas long-duration assets, like infrastructure, would be negatively affected by high or rising rates if cash flows do not keep up with inflation and higher rates. 

Valuations is another important consideration for Brewin Dolphin: “Some areas may have very attractive fundamentals. For example, like strong demand for data centres, however it is already a fairly crowded trade, so there are not many opportunities. 

“Then we spend a lot of time researching the management teams, their processes and their portfolios. We are looking for high-quality teams, robust investment processes and portfolios that reflect that.”

Multi-asset portfolio makeup

When it comes to what proportion of a multi-asset portfolio should be allocated to private market assets, it is not a one-size-fits-all, says Joan Solotar, global head of private wealth solutions at Blackstone.

Solotar says: “Financial advisers are seeking to solve the idiosyncratic needs of their clients based on a number of factors.

"With that said, we are seeing advisers gravitate towards different private market asset classes as a means of attaining both diversification and outsized returns, particularly during volatile market conditions.

"Our adviser pulse survey highlights that more than 40 per cent of advisers recommend clients allocate 10 to 20 per cent of their portfolios to private markets, similar to family offices that invest 20 per cent or more in private markets."

Todeschini says deciding on what level of private assets is appropriate in a portfolio, depends on the investor risk profile, targeted returns and investment horizon.

For investors with a long-time horizon, he says an allocation of 20 per cent-plus to private markets for diversification purposes makes sense. 

He says: "Tilting an allocation towards private equity and real assets makes sense for investors looking for returns, while tilting towards private credit would help more risk-averse investors with a shorter-term horizon and appetite for stable cash flow."

Schroders' Lowe adds: “We believe most investors should have some allocation to private markets.  How much however depends on the investor; their time horizon, risk/return profile, and ability to take on illiquidity. We regularly see allocations between 5 to 20 per cent based on the investors specific preferences and risk profile.”

At Quilter Investors, James says the firm’s multi-asset funds tend to have a maximum of around 6 per cent in private assets, but in all cases these are held in collective investment vehicles such as an investment trust, in order to enjoy diversification and portfolio management benefits. 

James adds: “We believe they are suitable investments given the due diligence that has been performed on the investment vehicle, the management team, the underlying process and the underlying portfolio of assets held, which is performed by our portfolio managers and in-house research team.

“Exposure is also set at a level appropriate for the liquidity requirements of the multi-asset portfolio and within the constraints set out by the strategic asset allocation, meeting long-term risk and return metrics.”

Managers of multi-asset portfolios must consider the ongoing liquidity requirements of their portfolio under stress-tested conditions. 

That could limit exposure to illiquid assets, which due to their nature are unlikely to be available to meet cash requirements at times of market stress. 

Ownership of some investment trusts can be highly concentrated and therefore difficult to trade regardless of being listed, which is a consideration and limits overall portfolio exposure, James explains.

What LTAFs offer

LTAFs are a relatively new type of open-ended vehicle designed to invest in long-term assets, with investment trusts remaining the primary way to access private market assets. 

James says in time they could offer limited scope to address the issue of liquidity, although they will be more suitable for income-producing assets than others that rely predominantly on capital growth. 

She adds: “While they will play an important role of addressing a key obstacle for investment, there is still a limited choice of LTAFs, but this is likely to expand over time and could address a gap in the market, allowing retail investors to access private markets through open-ended funds without an in-built liquidity mismatch.”

Ima Jackson-Obot is deputy features editor at FT Adviser