Extracting returns in private markets

Many institutional investors are raising allocations to private markets in search of a performance edge in a low-return world. We survey the current private markets landscape, pinpoint where we see the best opportunities – and illustrate how private assets work
in portfolios.

Years of easy-money policies have inflated valuations across capital markets. The result: Return expectations have been steadily compressing. A large number are opting to raise allocations to private markets in search of a performance edge, as a reward for taking on illiquidity and complexity.

The challenge: Investment opportunities in some private assets are in short supply, reflected in rising valuations. An influx of new capital to private markets, coupled with the fact that distributions have been outpacing capital calls, has resulted in record levels of dry powder. This amounts to roughly $1 trillion in private equity alone. See the chart below. More capital chasing fewer deals has resulted in lofty valuations. Prudent capital deployment is key in such an environment, we believe. This means not overpaying for deals and exiting at the right time.

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Global private market dry powder, 2000–2017

Key highlights

• Valuations are stretched for many large, auctioned private assets. We prefer less-explored markets. Among our top choices today: in private equity and real estate, firms and assets levered to technological disruption and e-commerce; in private credit, opportunistic credit and middle-market credit in developed markets and Asia; and in infrastructure, growth areas such as renewable power.
• We believe adding private markets to a portfolio can help broaden the opportunity set, increase return potential and enhance portfolio diversification, while in some cases adding a dose of inflation protection. Investors must be willing to deal with illiquidity and complexity. We show how private markets have a far greater variability of returns than public ones, so manager selection is critical.
• An outcome-oriented approach to investing in private markets is key. This means starting from the investment objectives and casting a wide net across regions, asset classes and capital structures in search of the best allocation mix to meet them. We show how allocations to private assets can potentially help meet a portfolio’s risk and return objectives while maintaining a buffer of liquidity to cover liabilities.