Private Markets: An opportunity worth exploring

Investing in private markets

Overview

With so many investment challenges to consider these days, it can be beneficial for investors to focus on long-term structural growth opportunities and specifically their exposure to private markets.

Find out more about the importance of private markets and how investors can add them to their portfolios in the current environment.

What are private markets?

Private market investing explained

Why the world’s biggest investors use private markets

US public pension allocation to private markets, historical returns of various asset classes, private markets an important asset class, private equity investments as a way to access a wider spectrum of equity opportunities, private capital growth forecast

Historical returns for various asset classes

Private markets have grown in popularity among institutional investors: average allocations for US public pension plans rose from 18% in 2012 to 20% in 2020, according to Public Plans Database. A key reason for this increase is the view that the asset class can improve both absolute and risk-adjusted returns for investors relative to traditional liquid portfolios and offer differentiated investment opportunities.

Historically, private markets have outperformed public markets by a significant margin. For many investors, this additional return premium can enable greater wealth accumulation and wealth transfer opportunities or support ongoing expenses. Illiquidity, value creation, and financial engineering are some of the drivers to this outperformance which we expect to persist in the coming years.

Private markets are also becoming an increasingly important asset class because of their access to opportunities not available through listed markets. For investors, this means gaining exposure to fast-growing and innovative businesses is becoming harder when only investing in listed equities. Importantly, upon listing, these companies are often larger and at a more advanced stage of their lifecycle. As a result, they may not offer the same growth profile and return opportunity. Therefore many investors are complementing public equity exposure with private equity investments as a way to access a wider spectrum of equity opportunities, add differentiated sources of returns to portfolios and potentially avoid missing out on returns. According to Preqin, private capital could grow by 14.8% per annum between 2021 and 2026 to reach USD 17.8tr from USD 8.9tr at the end of 2021.

How private investors should think about private markets in their portfolio

Achieve lifetime goals, preserve and grow wealth over generations, short-term goals, longer-term needs, purpose-built investment portfolio, retirement, illiquid assets, opportunity to fund lifetime expenses

It is the individual investor’s objectives and circumstances that primarily dictate the appropriate asset allocation choices. This also applies when thinking about how much to allocate to private markets. The UBS Wealth Way framework* is designed to help investors achieve their lifetime goals as well as preserve and grow their wealth over generations. The approach can help investors create a purpose-built investment portfolio that is implemented across three strategies:

Illiquid assets such as private markets can be incorporated in both the Longevity and Legacy strategies depending on investor circumstances, while the Liquidity strategy can help manage any risks associated with illiquidity. So, in a Longevity strategy, private markets can provide additional returns, which can help keep portfolios from being depleted by spending, allowing investors to spend more during the course of their lifetime, or even retire earlier.

A higher expected return in the Longevity strategy could also give investors the opportunity to fund lifetime expenses with slightly less capital, allowing them to set aside more excess capital for the next generation or for philanthropy in the Legacy strategy.

With the right plan, the illiquidity issue can be accounted for. A Longevity strategy is designed to help meet lifetime goals through both growth and income, and so we expect it to be gradually depleted throughout retirement. With this in mind, we generally recommend that investors approaching retirement consider transitioning the Longevity strategy toward a more liquid investment portfolio. This can include a mix shift within their private market portfolios toward semi-liquid fund structures or managers focused on core private real estate, private credit, and secondary market strategies. These strategies can provide regular distributions, shorter J-curves (the pattern of cash outflows and inflows associated with private market investing), or lower risk versus traditional private equity mandates.

* UBS Wealth Way is an approach incorporating Liquidity. Longevity. Legacy. strategies that UBS Financial Services Inc. and our Financial Advisors can use to assist clients in exploring and pursuing their wealth management needs and goals over different timeframes. This approach is not a promise or guarantee that wealth, or any financial results, can or will be achieved. All investments involve the risk of loss, including the risk of loss of the entire investment. Timeframes may vary. Strategies are subject to individual client goals, objectives and suitability.

How to think about private markets in the current environment

timing private markets, volatility offer opportunities, long-term opportunities, higher long-term returns, industrial and manufacturing businesses, inflation, healthcare, technology sector, commodity prices, above average returns.

Vintage year IRR comparison between global PE and public equities

Source: CAPE Global Private Equity Index, Cliffwater Direct Lending Index, Cambridge Real Estate Index, Global Real Estate Fund Index, MSCI AC World, Barclays Global Aggregate. Data covers period January 01 2001 and December 31 2021. For CDLI and GREFI Jan 2004-2021.

We don’t encourage timing private markets given the long lead times for deploying capital and longer holding periods. However, we do believe that periods of volatility offer opportunities. And it can be useful to switch focus from short-term concerns to long-term opportunities. Historically, investors who have continued to invest through prior volatile periods have been rewarded with higher long-term returns.

Private markets are an umbrella term for assets that are not traded on public exchanges. Investors in private markets face a wide menu of options in terms of asset class, investment strategy, or mode of investment.

Private markets are still very much overshadowed by listed assets in scale. Assets under management for private equity are equivalent to roughly 5% of the value of publicly traded stocks. But private markets are gaining in popularity. While private market investments require investors to lock up funds for longer, they have historically been rewarded with higher returns.

Where do we see opportunities in private markets

The recent banking stress raised questions over the implications for alternatives. Private markets continue to offer attractive investment opportunities for investors, but the current environment demands an extra focus on selectivity and diversification across different strategies.

Our preferred approach to investing in private markets, as in public ones, is to diversify. Investors should allocate to both private equity and private debt across geographies, managers, and strategies. In private equity, we currently seek exposure to value-oriented buyout and secondary funds which can take advantage of price dislocations. Secondaries in particular offer good value right now, in our view, with the average pricing declining to more attractive levels.

Here are three reasons why we believe recent developments in some corners of the private market can provide interesting investment opportunities for investors:

Lower valuations, market dislocations, and active ownership may drive opportunities for private equity investors.
Private debt’s near-term challenges are offset by a growing investment universe and higher yields.
We continue to see long-term value in private real estate, as the US banking fallout masks pockets of quality in logistics and multifamily apartments.

Investors should however keep track of the risks inherent to private markets. These include illiquidity, longer lockup periods, leverage, concentration risks and limited control and transparency of underlying holdings. While risks cannot be fully eliminated, it is possible to mitigate them through extensive due diligence and strict manager selection, and by diversifying across vintage years, strategies, and geographies.

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Non-Traditional Assets Disclaimer

Non-traditional asset classes are alternative investments that include hedge funds, private equity, real estate, and managed futures (collectively, alternative investments). Interests of alternative investment funds are sold only to qualified investors, and only by means of offering documents that include information about the risks, performance and expenses of alternative investment funds, and which clients are urged to read carefully before subscribing and retain. An investment in an alternative investment fund is speculative and involves significant risks. Specifically, these investments (1) are not mutual funds and are not subject to the same regulatory requirements as mutual funds; (2) may have performance that is volatile, and investors may lose all or a substantial amount of their investment; (3) may engage in leverage and other speculative investment practices that may increase the risk of investment loss; (4) are long-term, illiquid investments, there is generally no secondary market for the interests of a fund, and none is expected to develop; (5) interests of alternative investment funds typically will be illiquid and subject to restrictions on transfer; (6) may not be required to provide periodic pricing or valuation information to investors; (7) generally involve complex tax strategies and there may be delays in distributing tax information to investors; (8) are subject to high fees, including management fees and other fees and expenses, all of which will reduce profits.

Interests in alternative investment funds are not deposits or obligations of, or guaranteed or endorsed by, any bank or other insured depository institution, and are not federally insured by the Federal Deposit Insurance Corporation, the Federal Reserve Board, or any other governmental agency. Prospective investors should understand these risks and have the financial ability and willingness to accept them for an extended period of time before making an investment in an alternative investment fund and should consider an alternative investment fund as a supplement to an overall investment program.

In addition to the risks that apply to alternative investments generally, the following are additional risks related to an investment in these strategies:

Hedge Fund Risk: There are risks specifically associated with investing in hedge funds, which may include risks associated with investing in short sales, options, small-cap stocks, “junk bonds,” derivatives, distressed securities, non-U.S. securities and illiquid investments.
Managed Futures: There are risks specifically associated with investing in managed futures programs. For example, not all managers focus on all strategies at all times, and managed futures strategies may have material directional elements.
Real Estate: There are risks specifically associated with investing in real estate products and real estate investment trusts. They involve risks associated with debt, adverse changes in general economic or local market conditions, changes in governmental, tax, real estate and zoning laws or regulations, risks associated with capital calls and, for some real estate products, the risks associated with the ability to qualify for favorable treatment under the federal tax laws.
Private Equity: There are risks specifically associated with investing in private equity. Capital calls can be made on short notice, and the failure to meet capital calls can result in significant adverse consequences including, but not limited to, a total loss of investment.
Foreign Exchange/Currency Risk: Investors in securities of issuers located outside of the United States should be aware that even for securities denominated in U.S. dollars, changes in the exchange rate between the U.S. dollar and the issuer’s “home” currency can have unexpected effects on the market value and liquidity of those securities. Those securities may also be affected by other risks (such as political, economic or regulatory changes) that may not be readily known to a U.S. investor.

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Private Markets: An opportunity worth exploring

Overview

What are private markets?

Where do we see opportunities in private markets

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“Spurring innovation in alternative assets.”

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