Since the emergence of “Modern Portfolio Theory” and the “Capital Asset Pricing Model” in the late 1960s, institutional investors have taken a quantitatively driven approach to portfolio construction, looking to create portfolio diversification and obtain better risk-adjusted returns by balancing their asset-class exposures. This journey has seen several important advancements in thinking about how to optimally achieve desired results.
Funds that want to take the total portfolio approach first need to get the total portfolio view. To do that they not only need data – and lots of it – but a rock-solid understanding of exactly how they’re going to use it.
Big super ‘a tough nut to crack’ for private markets managers
Total global private assets under management are expected to double to $18.3 trillion in the next five years, according to Preqin’s Future of Alternatives 2027, released Wednesday (October 5). Venture capital leads as the fastest growing asset class, while the risk-off environment could see slower growth in previously strong assets, including private equity, which is responding to the rising cost of debt and weaker valuations, and hedge funds, which could see a return to outflows.
“Private markets have been in a super cycle over the past decade,” said Preqin CEO Christoph Knaack (photo at top). “Due to lower risk adjusted returns in most traditional public asset classes, investors have had to look further afield to find alternative sources of return, “However, the deterioration of the macroeconomic climate over the past year, from rising inflation and interest rates to geopolitical threats, means investors are now operating in a more challenging environment.
“Against this backdrop, we expect to see more sustained growth in the asset classes which have historically performed well in more volatile markets, and which are able to provide inflation protection, such as infrastructure, natural resources, and private debt. Continued demand for these asset classes, coupled with a growth of retail investor interest in building allocations to alternatives, will drive private capital AUM to new heights over the next five years.”
Still, the Australian market for private investments has been a “tough nut to crack” for many international general partners (GPs). The strong performance of the domestic market and Australia’s “comparatively strong” macroeconomic credentials have all contributed to big super’s home country bias.
But that bias “is no longer assured” – not because of a shift in investment preferences, but out of necessity. Super funds are simply too large to continue investing in the Australian equity market without pushing valuations higher and creating “unfavourable liquidity conditions”. More capital has flowed into offshore equities, but Preqin views this as only “the first stage of investment into international markets”.
“As investment teams have become more familiar with new markets, the sophistication of investment allocations has increased,” the report says. “As a result, investment teams have felt more confident and capable about allocating to private equity and private capital funds.”
But the Australian market for private investments still faces a unique set of challenges when compared to its global peers – mainly due to the advent of the Your Future Your Super (YFYS) reforms, which have encouraged an even higher level of scrutiny on the level of underlying fees that super funds are paying to their investment managers. While Preqin says that’s a positive development, it can also lead to pressure to reduce fees regardless of a manager’s potential for outperformance.
“In turn this may limit the scope for the deployment of capital into private capital as well as reducing the opportunity set of GPs that are willing to market to superannuation schemes,” the report says. “We are aware of a number of prominent global GPs that have decided to refrain from marketing to super schemes as a result of what they see as excessive demands for lower fees.”
The composition of the benchmarks themselves is also problematic, with the benchmark used for real estate and infrastructure considered “more difficult to outperform” and potentially limiting incentives to allocate to those asset classes on the margin compared to others. Super funds already have “comparatively high allocations” to those asset classes compared to global pension funds, which Preqin says might see a slower pace of capital deployment into them going forward.
But with private equity benchmarked against a combination of domestic and international public equities – and relative confidence on the part of super funds that private will outperform public – incentives to allocate to PE are “strong in relation to other asset classes.”
Consolidation within superannuation – which has seen an approximate eight per cent annual decline in the number of funds over the last eight years – will also enhance the bargaining power of funds and “underline the power of investment consultants”, such as JANA; for the most part, GPs will have to receive the recommendation of a prominent investment consultant to successfully raise capital from a super fund. The appetite for allocating to first time managers is also low, though some super funds are prepared to invest in first-time funds spun off from existing PE managers with a visible track record.
