Ideas for allocation:

Pursuing investment goals with private markets

Your clients are more like institutions than you think they are

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Lin_Gary

Gary Lin

Managing Director, Head of Global Portfolio Strategy and Solutions

Introduction

We often think of large institutional investors like pension funds, university endowments and sovereign wealth funds as behemoth organizations with highly complex investment decision-making processes. In contrast, many private wealth clients invest to solve very human problems, like preparing for retirement, for college savings, or for a more comfortable lifestyle in the future. Different as they may seem, are there lessons that these large institutions hold for your clients?

While it might be true that many large pools of institutional capital are intricate, sophisticated organizations, at the same time, these institutions exist to pursue many of the very same goals as your clients. To examine this further, let’s take three models of investors: the saver, the spender, and the grower. You’ve probably found that many of your clients fit these descriptions and their portfolios are built accordingly. What you may not realize is that institutional investors fit these descriptions too.

The Saver, The Spender, & The Grower: Defined

The Saver

Carefully saving to meet a tight budget.

Maybe your saver is a family with young kids who have a lot of expenses, but know they need to put money away for education and for retirement. Such families may skew towards conservative investments as they are afraid to put capital at significant risk and meeting their investment goals means keeping a tight budget. A lot of university endowments look like the saver. The average university endowment had a three-year return of around 7.5% in 2022, but they paid out almost 5% in contributions to their university’s operating budget.1 In a world where costs of education are skyrocketing, university endowments can feel pressure to help meet current expenditures while at the same time growing their asset base for the future.

What do these large institutional investors have in common?

The thing that all these types of institutional investors—growers, spenders, savers—have in common is that they generally rely on private market investments like private equity, real estate, and private credit to help enhance their returns, boost their diversification alternatives, and generally give them better riskadjusted performance than they may get with more traditional stock/bond portfolios. Some do it to catch up, some do it to get ahead, some do it to ease the pressure of meeting current obligations while saving for tomorrow.

Icon - Saver (60x60)

The Saver: Preparing for the future with private markets

Let’s take college endowments, the savers. A 2023 study by the National Association of College and University Business Officers reported summary asset allocations for university endowments by size of the endowment:

Figure 1

Summary asset allocations for U.S. college and university endowments and affiliated foundations4 (Fiscal Year 2022)

Size of Endowment % U.S. Equities % Fixed Income % Non-U.S. Equities % Global Equities % Alternative Strategies % Other
Over $1 Billion 8.80 9.54 9.26 6.80 62.61 2.99
$501 Million to $1 Billion 21.43 14.94 13.96 5.73 42.87 1.07
$251 Million to $500 Million 21.04 15.83 11.26 9.00 40.55 2.32
$101 Million to $250 Million 28.19 19.16 13.27 8.66 30.11 0.61
$51 Million to $100 Million 34.34 23.70 12.65 7.76 20.39 1.16
$25 Million to $50 Million 39.12 26.44 14.04 3.62 16.05 0.73
Under $25 Million 44.71 32.68 13.10 1.34 7.77 0.40

The column labeled “Alternative Strategies” tells an important story. Two things really jump out. First, college endowments of all sizes devote an important portion of their portfolio to alternatives. Even the smallest endowments have north of 7% of their allocation to alternative strategies. Such an allocation means that a $25 million university endowment – which is tiny by college endowment standards – is putting around $2 million in these alternative investments.

The second thing that jumps out is just how dominant alternative strategies appear to be for the biggest funds. The larger the endowment, the lower the exposure to public markets. The biggest university endowments generally allocate more than half of their investment portfolio to alternative strategies. The reason this statistic is noteworthy is that the biggest endowments are the ones that have the biggest responsibility to fund the operating budgets of their schools. Schools with tiny endowments rely predominantly on tuition for operations, but public institutions with large endowments rely quite heavily on those endowments to meet the day-to-day operating costs. These schools are the ones that are most like your savers.

A key takeaway here is that savers of all sizes and levels of sophistication may have room in their portfolio for private market investments. Updating client portfolios to include thoughtful exposure to alternative assets can potentially give savers an edge as they prepare for tomorrow while meeting the needs of today.

Icon - Spender (60x60)

The Spender: Using private markets to help close the gap

Many state pension funds face a chronic problem: they are underfunded. That’s bad news for many state employees across the country because it puts their retirement security at risk. But the good news is that some pensions have closed the gap in recent years through a combination of prudent investment and careful management. Their experience can offer lessons for the spenders out there.

A 2023 report by the non-profit Equable Institute illustrates the role that private market investments have played in the catch-up process that many pension funds have undertaken. They report that “There is no way that pension funds can meet their investment targets using simple stock and bond passive portfolios,” and then point out that pension funds either have to face the tough political choice of “increasing contributions into pension funds beyond their currently historically high levels”, or they must change their investment portfolios. Investments in private markets by state pensions have grown from around $100 billion in 2001 to over $1.6 trillion in 2022 and now comprise 34% of pension fund investments, the largest share in history.5

Figure 2

Asset allocation trend of state and local pension funds5 (2001-2022)

  • Public Equities (U.S. & Global)

  • Fixed Income & Cash Holdings

  • Commodities & Miscellaneous Alternatives

  • Real Estate (Real Property, Infrastructure, and REITs)

  • Hedge Fund Strategies

  • Private Equity Investments

Icon - Grower (60x60)

The Grower: Seeking higher absolute returns with private markets

Sovereign wealth funds are perhaps the most bullish investors when it comes to allocating capital to private markets.

Of course, this philosophy is partly a function of their size. Sovereign funds manage large pools of capital, so they can likely afford to have a large staff of internal investment managers and analysts. These resources allow them to take an even more aggressive approach to alternative strategies than many other investors. The impact can be seen in the fact that the average large sovereign fund has 10% of its portfolio invested in direct strategic investments – private market investments that it originates on its own.

Figure 3

Asset allocation of sovereign wealth funds worldwide6 2023

  • Equities

  • Fixed income

  • Cash

  • Illiquid alternatives

  • Liquid alternatives

  • Direct strategic investments

Consider a page from the institutional investor playbook

The modern investment landscape is becoming an increasingly complex place to seek consistent returns with portfolios limited to traditional public equity and fixed income. Large institutional investors address this complexity by including investments in the private markets in their portfolios as they pursue potentially higher returns and increased diversification.

Thanks to advancements in technology and fund structures, private markets are more accessible than ever for private wealth clients. For advisors interested in introducing exposure to private market assets into the portfolios of clients, one method is to consider moving from a traditional stock/bond portfolio to a portfolio that offers exposure to private credit. Historically, private credit strategies such as direct lending have paid around 2–4% more per year than syndicated loans and high yield bonds, positioning them as an attractive potential alternative for income-seeking investors.7

Institutional investors of all types have embraced private credit. The asset class has grown dramatically over the past 15 years, and a recent Preqin survey indicates that growth should continue as sentiment towards private credit remains positive among institutions. 90% of survey respondents reported that private credit had met or exceeded their return expectations. Over half of those surveyed intended to increase their allocations to private credit, while another 40% intend to maintain exposure at their current levels.8

Private credit may represent a simple and direct way to offer clients exposure to private markets and help them pursue investment goals, whether they are savers, spenders or growers.

Endnotes

  1. Source: 2022 NACUBO-TIAA Study of Endowments
  2. Source: Nasdaq.com – “10 Best and 10 Worst States for Pensions”, published January 16, 2024.
  3. Source: Sovereign Wealth Fund Institute – Fund Rankings: Sovereign Wealth Fund
  4. Source: 2022 NACUBO-TIAA Study of Endowments
  5. Source: Equable Institute – State of Pensions 2023 Annual Report
  6. Source: Statista Survey of global sovereign wealth funds, July 2023
  7. Sources: Bloomberg, Cliffwater. Direct lending is represented by the Cliffwater Direct Lending Index. Syndicated Loans represented by the S&P/LSTA Leveraged Loan Index. High Yield bonds represented by the Bloomberg Barclays High Yield Index.
  8. Source: Preqin 2024 Global Report: Private Debt

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