Client Insight Unit (CIU)

Hi and welcome back to another Quick Insights.

Today, I’m going to do something I haven’t done in a couple of years. I’m flying to see a client!

I'm Calvin Yu, and in this series, we share portfolio insights on common investment challenges.

With falling returns expectations, more and more investors are exploring alternative investments, like private equity. But with so many private equity strategies, how do you build a balanced program that meets your objectives? 

So I’m in Miami to speak with a client about this very topic. Specifically, they’re concerned they’re not going to meet their private equity target and wanted to know how best to complement their existing investments.

Alright – so I’m about to head into the meeting now. I’ll let you know how it goes. See you in a bit!

And we’re back! It’s so great to see clients in person again!

The meeting went well! We analyzed the client’s existing private equity program and identified strategies to help achieve their goals.

So let me share 3 key insights from the analysis, starting with the first insight - Planning Ahead.

The client’s CIO, who inherited the private equity portfolio, wanted to understand their starting point as they plan their targeted journey. 

Based on our analysis, the existing private equity portfolio was fairly diversified across strategies and vintages, but they were focused on primaries.

Also, as we compared the private equity allocation relative to the target, the portfolio was quickly running off, so additional commitments were needed to meet the target allocation.

Given the portfolio runoff and the concentrated positions, what do you need to consider to build a balanced private equity portfolio?

Well that brings me to the second insight, which is Considering the Components.

The main building blocks of private equity include primaries, secondaries, and co-investments.

Primaries are typically invested in a general partners fund and forms the fundamental core of a well-diversified private equity program.

Secondaries typically involve the purchase of existing interests in private equity funds, which are often sold at discounts. This allows the investor to gain private equity exposure immediately at potentially attractive valuations.

Co-investments are typically specific deals invested alongside general partners. This also allows the investor to gain economic exposure immediately, and to actively influence the portfolio construction, while saving on fees.

Each of these offer different benefits that help build robust private equity portfolios. For this analysis, we wanted to see how each part complemented the client’s existing investments.

And so, that brings me to the third insight, which is Balancing with Building Blocks

The proposed solution largely included the core part of the portfolio being built from primaries, with broad exposure to well established general partners.

This was amplified by secondaries and co-investments, which helped mitigate the J-curve, gaining private equity exposure faster, and potentially enhancing the net returns. 

As a result, the proposed solution improved the client’s ability to reach their private equity target in an efficient manner.

From this study, we partnered closely with the client to analyze different private equity investments and designed a robust solution that was more in line with their objectives.

So if you want to learn more about analyzing your private equity portfolio, please reach out to your BlackRock relationship manager.

Thanks for watching and I'll see you with the next Insight.

Clients provide data to BlackRock regarding their existing portfolios. The case study and screenshots in this material are for illustrative purposes only and are intended to describe BlackRock’s capabilities. Actual account outcomes may vary.

THE INFORMATION CONTAINED HEREIN MAY BE PROPRIETARY IN NATURE AND MAY NOT BE REPRODUCED, COPIED OR DISTRIBUTED WITHOUT THE PRIOR CONSENT OF BLACKROCK, INC. (“BLACKROCK”). These materials are not an advertisement and are not intended for public use or dissemination.

Opinions and estimates offered constitute our judgment and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, accounting, legal or tax advice. You should consult your tax or legal advisor regarding such matters.

This material may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections, forecasts, estimates of yields or returns, and proposed or expected portfolio composition. No representation is made that the performance presented will be achieved by any asset allocation or investment, or that every assumption made in achieving, calculating or presenting either the forward-looking information or the historical performance information herein has been considered or stated in preparing this material. Any changes to assumptions that may have been made in preparing this material could have a material impact on the investment returns that are presented herein by way of example.

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offeror solicitation to buy or sell any securities or to adopt any investment strategy. The information and opinions contained in this material are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. There is no guarantee that any of these views will come to pass. BlackRock does not guarantee the suitability or potential value of any particular investment. Reliance upon information in this material is at the sole discretion of the reader.

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Calvin: Hi Emanuella – I have a question about the new regime for fixed income, could we catch up over coffee?

Emanuella: Yeah, let’s do it!  

Calvin: So we’re meeting with a client that’s been underweight fixed income for a while, but they want to rethink the allocation given where rates are now. What do you think?

Emanuella: These conversations are happening a lot right now, and it’s not surprising given where yields are.

Calvin: Yeah, but beyond pointing out that yields are higher, what else makes fixed income so appealing right now?

Emanuella:

We’ve done some analysis on this recently, let me pull it up. 

Emanuella:

Higher yields is huge. But it’s also important to point out that fixed income yields are higher for the right reasons. Spreads aren’t blowing out because expected losses are rising. Rather, the risk-free rate is going up because the Fed has been hiking. That’s the red portion of the bars – you can see how much that’s increased relative to recent history. That means safe investment grade assets are offering an unusually high rate of return and investors don’t have to take meaningful risks to achieve their return targets. And with so much of that yield coming from the risk-free rate, you’re also protecting portfolios from downside if the economy slows because there’s a lot of room for rates to rally if the Fed has to eventually ease.

Calvin: That’s interesting. How do you think that’s impacting portfolio construction and asset allocation?

Emanuella:

Based on our analysis, at the end of 2021, to hit an expected return bogey of around 6% you had to really load up on risky equities, given how low fixed income yields were. Flash forward to the end of 2022 all the way to the right, and you can hit that same near-6% return target by constructing a portfolio that’s mostly fixed income with a substantial portion coming from investment grade assets. That’s the benefit of today’s higher rate environment. And in moving away from equities and diversifying across a broad array of fixed income sectors you can substantially cut down on portfolio risk.

Calvin: That’s compelling. But are you giving up upside by choosing fixed income over riskier options?

Emanuella:

Well, more risk may mean more potential return. It’s hard to argue with that.

Emanuella:

But if you take a look at our analysis on the right-hand side, when looking at risk-adjusted returns, a portfolio with an 80% fixed income allocation potentially has better expected returns per unit of risk than say a 20% fixed income, 80% equity portfolio.

Emanuella:

To get a sense of downside risks protection, we stressed the portfolios under different market shocks. If you look at the results, the riskier portfolios may underperform the less risky portfolios in stress environments. Those are the left and middle panels. But here, in a muddle through growth scenario like what we expect ahead, we think returns could be quite similar across portfolios. So you may be protecting against the downside and not giving up much upside if growth is modest. 

Emanuella:

Now, if growth ends up meaningfully surprising on the upside, riskier assets could have a lot of room to run. But if we compare the earnings yield on the S&P 500 to the yield on the US Aggregate index, the two are actually pretty similar. The red line shows the gap between the two metrics close to zero– suggesting the expected return on fixed income relative to equities is the most attractive it’s been in decades. 

Calvin: Gotcha, these are all great themes to consider. Anything else to keep in mind?

Emanuella:

Well, I think the case for fixed income is strong, but we’re still in a pretty fraught environment. 2022 saw extreme Fed rate hikes and market volatility and while things may cool in 2023 we don’t think you can just ride beta – we think dispersion across categories and sectors could be huge, similar to prior years. We already see pretty meaningful dispersion in yield across fixed income sectors depending on geography, credit quality and maturity spectrum. This more challenging backdrop argues for a more dynamic and flexible approach to fixed income investing. Returns may be more driven by income, tactical positioning shifts and security selection, rather than compression of yield and term premium ahead.

Calvin: Sounds great. This is a great way to help clients analyze the role that fixed income can play in this new regime. So thanks for the chat, Emanuella!

Emanuella: My pleasure. Have a good one!

Clients provide data to BlackRock regarding their existing portfolios. The case study and screenshots in this material are for illustrative purposes only and are intended to describe BlackRock’s capabilities. Actual account outcomes may vary.

THE INFORMATION CONTAINED HEREIN MAY BE PROPRIETARY IN NATURE AND MAY NOT BE REPRODUCED, COPIED OR DISTRIBUTED WITHOUT THE PRIOR CONSENT OF BLACKROCK, INC. (“BLACKROCK”). These materials are not an advertisement and are not intended for public use or dissemination.

Opinions and estimates offered constitute our judgment and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, accounting, legal or tax advice. You should consult your tax or legal advisor regarding such matters.

This material may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections, forecasts, estimates of yields or returns, and proposed or expected portfolio composition. No representation is made that the performance presented will be achieved by any asset allocation or investment, or that every assumption made in achieving, calculating or presenting either the forward-looking information or the historical performance information herein has been considered or stated in preparing this material. Any changes to assumptions that may have been made in preparing this material could have a material impact on the investment returns that are presented herein by way of example.

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offeror solicitation to buy or sell any securities or to adopt any investment strategy. The information and opinions contained in this material are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. There is no guarantee that any of these views will come to pass. BlackRock does not guarantee the suitability or potential value of any particular investment. Reliance upon information in this material is at the sole discretion of the reader. Past performance is not indicative of future results.

Investing involves risk, including possible loss of principal.

Equity and fixed income characteristics and allocations are for informational purposes only. Such characteristics and allocations are not intended to be predictions or projections of any portfolio's performance. Neither asset allocation nor diversification can ensure profit or prevent loss.

Investing in the bond market is subject to certain risks including market, interest-rate, issuer, credit, and inflation risk. Mortgage and asset-backed securities may be sensitive to changes in interest rates, subject to early repayment risk, and while generally backed by a government, government-agency or private guarantor there is no assurance that the guarantor will meet its obligations. High-yield, lower-rated, securities involve greater risk than higher-rated securities; portfolios that invest in them may be subject to greater levels of credit and liquidity risk than portfolios that do not. Investors will, at times, incur a tax liability. Income from municipal bonds may be subject to state and local taxes and at times the alternative minimum tax.

Aladdin Portfolio Risk Analysis: Charts and graphs provided herein are for illustrative purposes only. Neither BlackRock nor the Aladdin portfolio risk model can predict a portfolio's risk of loss due to, among other things, changing market conditions or other unanticipated circumstances. The Aladdin portfolio risk model is based purely on assumptions using available data and any of its predictions are subject to change. For BlackRock products, data about the specific underlying holdings are used when applying the Aladdin risk model. For third party funds, BlackRock uses underlying holdings, or in certain cases, determines appropriate proxies for relevant holdings using a combination of Morningstar and other publicly available data sources. Product specific inputs are typically based on the latest disclosed data, which may be lagged.

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