Why portfolio diversification matters

The most optimistic estimate for the classic 60/40 investment portfolio suggests annual returns for the next decade will be only just over half those investors enjoyed in the past 10 years, according to the Alternative Investment Management Association’s Global Head of Research and Communications Tom Kehoe.

Which makes relying on public market equities and bonds to deliver the risk-adjusted performance investors seek, especially given current and envisaged future levels of volatility, a perilous strategy. Investors instead will need to diversify.

Take a leaf out of institutional investor books

Faced with elevated levels of volatility, persistent inflation, further rate hikes and the prospect of recession, or even stagflation, two-thirds of the institutional investors surveyed for the 2023 Natixis Outlook Survey¹ believe a portfolio comprised of 60% equities, 20% fixed income and 20% alternatives will outperform a traditional 60/40 mix.

Evidence indicates they’re right.

According to new analysis in the British Private Equity and Venture Capital Association’s latest Performance and Public Market Equivalent (PME) Report, private equity and venture capital funds have collectively outperformed the public market² every year since 2001.

BVCA members’ funds that started investing between 2001 and 2018 generated 41% more from investing in private capital than an equivalent public equity investment in the MSCI Europe Gross Total Return Index, and 34% more than investors would have earned from the FTSE All Share Total Return Index.

No wonder that among the institutional investors surveyed for the Preqin Alternative Assets H2 2023 Investor Outlook³, 80% now allocate to at least one private asset class, while 39% allocate to three or more.

PE popularity

Private equity remains most popular, with 63% having a PE allocation. Between 2017 and June 2023, tracked investor allocations toward private equity have nearly doubled⁴, while PE assets under management soared from $2.98 trillion in December 2017 to $6.55 trillion by December 2022. Over a third of those surveyed plan to allocate more capital to the asset class in the next 12 months.

The Natixis survey reported similar results. It found institutions are most bullish on private equity, with private markets featuring “prominently in yield replacement strategies” and, increasingly, as a way to make up for lacklustre equity returns. Enticed by the attractive return potential and reliable payment schedule on offer, 43% planned to increase private equity and 36% expand their private debt investments.

Investor sentiment in the venture capital space is more muted at present. But now could actually prove an opportune time. PitchBook says the market has become the most investor-friendly in decades⁵ (as underscored by the increase in down rounds).”

Increasing interest in private debt

The opportunities offered by private debt featured even more prominently in the Preqin survey. The asset class has most outperformed investor expectations, with 90% of investors surveyed by Preqin reporting it had “met or exceeded expectations over the past year.”

This trend is expected to continue, with over half of investors (53%) predicting private debt will perform even better over the coming year. As a result, “it is the asset class where the highest proportion of investors surveyed intend to increase allocations over the next 12 months (45%).”

Much of the interest in private debt, Preqin noted, is due to the current economic environment and concerns around elevated interest rates lingering, with almost two-thirds of respondents pointing to reliable income as the main reason for investing in private debt.

The case for private credit has strengthened as base rates have risen⁶, contends Zach Lewy, founder, CEO and CIO of alternative assets manager Arrow Global. “Investors are accessing yields solidly in the double-digits for well protected investments,” he said, with private credit now an entrenched part of the European landscape.

It’s a view echoed by Goldman Sachs Asset Management⁷: “In a higher-for-longer rate environment, we see opportunities for investors to earn equity-like returns [in the double digits] in private credit … The strategy can offer incremental income generation and greater resiliency during periods of heightened volatility, serving as a potentially strong complement to traditional fixed income.”

Individual under-allocation

Compare this institutional embrace of private markets to the portfolio make-up of individual investors. A McKinsey US wealth management study, for instance, reported the average retail investor allocated just 2% of their assets⁸ to private markets.

Fortunately, for investors seeking to benefit from broader portfolio diversification, moving into private markets has never been easier.

This content is for information purposes only. Treble Peak does not provide investment or tax advice, and information on this website should not be construed as such. Potential investors should seek specialist independent tax and financial advice before investing in any alternative investment.  Past performance is not a reliable guide to future returns. Your capital is at risk.

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