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NFPs struggle with the private markets push

Not-for-profit (NFP) investors are keen to jump into the private markets, but are being held back by the complexities of manager selection and concerns around cost.

It’s been a common refrain of the world’s largest sovereign wealth and pension funds that private markets will soon trump public as the expected returns of listed equities moderate amidst slowing global growth. In recent years the Future Fund has increased its private equity allocation from 13 per cent to 17.5 per cent, while megafund AustralianSuper has indicated it will go from five per cent to seven per cent in short order – to say nothing of the monster allocations that Canadian pension funds have been running for decades.

And even smaller not-for-profits (NFPs) are getting in on the action, according to Mercer’s latest global survey of the sector. What used to be a 10 per cent weight within their portfolios has in some cases grown as high as 25 per cent – and that’s just in private equity.

“Private equity used to be seen as cutting edge, but it has become much more mainstream,” said Michael Forestner, Mercer global co-CIO. “That said, investors are becoming more adventurous in how they access the asset class. When they had small allocations they tended to invest in their home countries and stuck to things like buyouts. But as their allocations have grown, they have increasingly entered more complex areas such as venture capital, Asia, secondary investments and co-investments.”

But while 65 per cent of respondents identified diversification away from traditional asset classes like fixed income and equities as their biggest investment opportunity in the next three years, many are still leery of going all in on private markets.

Forty-four per cent of respondents said their portfolios were more complex today than they were a year ago as a result of the private markets push, resulting in significant outsourcing of the function, while those that are yet to take the leap identified high fees, illiquidity and a lack of resources to assess investment opportunities as holding them back. Others found the manager selection process and the investment instruments too complex. But Mercer’s report finds that those concerns are probably misplaced.

“Interestingly, the concerns driving some participants’ lack of exposure to private markets are not borne out by the experience of those that are invested,” the report says. “… Despite 43 per cent of non-private markets investors citing concerns about high fees as a reason for not being invested, only nine per cent of those that are invested believe returns have not compensated for the higher fees.”

“A lack of internal resources to assess investment opportunities is also given as a reason for not investing in private markets. The most positive investments experience is among private equity investors, where 67 per cent of respondents say their positions in the sub-asset class met the investment return objectives over the past three years. This was followed by real estate and then infrastructure.”

These investors have historically funded their increased private markets allocations by reducing their exposure to hedge funds, which have suffered from a decade or so of lacklustre performance. That trend is now reversing as performance gathers steam once again, and 23 per cent of respondents said they were likely to increase their allocations to hedge funds in the next three years. NFPs are also using their private market allocations as a means of implementing impact or ESG investment strategies, a “relatively new approach for private markets investors.”

“The (survey) made clear investors’ growing appetite for private markets, which I think is interesting from an ESGG perspective,” said Georges Dyer, executive director of the Intentional Endowments Network (photo at top). “A topic that comes up frequently in our network’s conversations is whether investors should divest from fossil fuel companies.”

“One view suggests that doing so might lead these firms to turn to the private markets, where they’re under less investor scrutiny, so their emissions might actually increase. I think the entry of more mission-drive institutions like we find in the NFP sector will be important in increasing scrutiny of private companies.”

Mercer surveyed 133 NFPs with investment ranges of $100 million or less to $1 billion or more, including private foundations and charities, indigenous corporations, and educational, faith-based and healthcare organisations.

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