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.
WTW laboratory for ‘new breed’ of manager
Willis Towers Watson has formed a working group to assess the potential for what it calls a ‘new breed’ of investment management firm that invests across the equity spectrum, from private to public markets.
The working group, bringing together researchers from both sectors within WTW, was established in March. The global asset consulting firm believes there are strong structural tailwinds to support the continuing rise of private equity in institutional portfolios. However, the private equity industry itself needs to evolve the way it structures its investments to fully capture the growth potential.
In its latest paper, ‘Institutional Allocation to Private Equity‘, WTW says that becoming a public company is less desirable than before and private companies are stating private for longer.
One of the focus areas for the working group is the potential for a new type of passive offering within private equity that allows asset owners to access and hold these investments in a cost-effective way.
Since many private businesses are already well-established with strong management in place and strong cash flows, the working group believes they are well positioned to compound earnings over a longer time horizon than current structures allow, the paper says.
The firm is also challenging private equity managers to take additional steps to improve their ESG standards. As part of this effort, WTW has developed a set of guiding principles to help the managers formulate their own frameworks, including assisting them to report on the carbon emissions being generated by their investments as a first step on a route towards net zero.
Andrew Brown, WTW’s London-based head of private equity, said: “What we currently have within the private equity space is a model that hasn’t changed in the last few decades. Whilst that structure has performed well over this period, we are increasingly seeing capital moving away from defined benefit pension schemes into defined contribution, so there is a need to innovate in order to identify a structure that enables a wider investor base to access opportunities.
“This could mean relooking entirely at the way that some private equity funds are structured. For example, specific fund terms can mean that private equity managers may be under pressure to sell out of investments prematurely in order to facilitate further fundraising; whereas long-dated funds and evergreen structures could be a way of mitigating the need to do so…”
Michael Slaven, associate director, equity research in Australia, said: “There is growing interest from asset owners wanting to access private equity through co-investments. The aim is to both reduce fees and to take a more targeted and deliberate approach to building private equity portfolios designed to achieve a specific set of objectives.”
