Plotting a path forward in private markets

Institutional investors started 2020 with their largest-ever allocations to private markets. To see how these investments have fared amid market shocks and how long-term portfolio objectives are being impacted, we recently hosted a webcast, Re-assessing Private Markets Portfolios.

On the call, Mike Pyle, Global Chief Investment Strategist for the BlackRock Investment Institute, was joined by Mark Everitt, Head of Investment Research and Strategy for BlackRock Alternative Investors; Pam Chan, CIO and Global Head of the Alternative Solutions Group; and Alan McKenzie, CIO for Family Offices.

The group discussed the broad themes impacting private companies and investors, shared thoughts on rebalancing portfolios, and identified several potentially attractive investment opportunities. Following are highlights of their conversation.

What big themes are playing out across private markets companies?

Broadly speaking, corporates are looking to bridge the uncertainty to better economic conditions, and they’re often drawing revolving commitments from their banks. Even less severely affected companies are looking to add liquidity, and we are getting approaches from larger companies that might not normally look to the private channel for liquidity.

There are differences across sectors, of course, with energy companies having been particularly hard hit and tech companies proving more resilient. In private credit, we’re seeing financial restructuring and liquidity activity in underlying investments. In infrastructure, there’s a divergence between harder hit assets, especially in transportation, and those less affected, such as power.

Ultimately, we expect that a lot of very good companies are going to have to face the question of restructuring, and that private markets will have a major role to play. The private markets will be making judgments—including in heavily stressed sectors—about who the winners and losers are likely to be amid potentially substantial industry consolidation. Consequently, it may be worth backing companies or assets in heavy-stress areas, if they are likely to be among the eventual winners in their sector.

The industry is also seeing capital raising for distressed debt funds. Over the next year, we think there will be a significant opportunity in stressed and distressed, and that much of this will come in the form of partnering with corporates to provide capital solutions.

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We expect that a lot of very good companies are going to have to face the question of restructuring, and that private markets will have a major role to play.

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What about private market investors, how are they approaching their allocations as the crisis progresses?

Early on, the big focus was on liquidity. Whether you’re talking about a pension plan with upcoming benefit payments, a foundation with grant disbursements, or a family office with an annuity distribution, the main concern was on finding liquidity in stressed markets—both to meet these obligations and to be prepared for potential capital calls.

Obviously, now that markets have stabilized on the back of massive policy response, that concern has faded somewhat. So, clients are increasingly focused on valuations and on understanding the magnitude of the negative returns that they’ve experienced. We know that private market valuations will lag public valuations by a couple of quarters, so clients are assessing the impacts on their private market exposure and trying to get a handle on potential impairments.

At the same time, clients recognize that these types of dislocations create opportunities, and they are shifting their focus in that direction. At this juncture, most clients are focused more on forward-looking assessments and on positioning to capitalize on potential opportunities and less on what has happened in the past.

As private investors look to the future, how should they be thinking about rebalancing their portfolios and diversifying their exposures?

The past few months are a very stark reminder of the power of diversification: across sectors, across geographies, across sponsors, and certainly across vintage years. Recent experience reinforces why, when we are building portfolios, we view effective diversification as paramount. And now is certainly an opportune time for investors to assess how well-diversified their total portfolios are.

As we mentioned earlier, liquidity is also a primary concern. When you’re constructing your strategic asset allocation, you should be considering different scenarios under which liquidity does not exist, but you have to make a distribution out of your asset pool. We do this with clients in the very early stage of building portfolios, but when you have a situation like the current one, it’s a great opportunity to go back and reassess whether you modeled things correctly or whether you need to be thinking about some things differently. So, what we are doing with a lot of clients now is effectively going back and re-underwriting the allocation to private markets that we put in place to see if changes are warranted. Ultimately, the goal is to take that liquidity issue off the table as best as we possibly can.

Finally, we think that clients should not be beholden to historic asset class labels when they’re allocating to private markets. Instead of thinking rigidly in terms of, say, private equity or private credit, we believe in taking much more of an opportunistic approach. What we’re trying to do is harvest an illiquidity premium, and where we get that premium is somewhat immaterial. We’ve found that approaching private markets in this manner acts as a very natural diversifier. Because opportunities move in and out of favor, if you take an opportunistic approach, you’re putting capital to work across different opportunity sets over different periods of time, regardless of what traditional bucket they might fall into.

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The past few months are a very stark reminder of the power of diversification.

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Where are you seeing attractive opportunities right now?

We are seeing opportunities in quite a few places, which can be broadly grouped into three categories: liquidity-based opportunities, sector-based opportunities, and opportunities driven by an imbalance in the supply-demand dynamic for capital. On the liquidity side, amid dislocation, we anticipate further forced sales of high-quality assets where the holder of the assets is under pressure. In many of these instances, the assets themselves are unimpaired, but there is a pricing discount that reflects the need for execution certainty and timeliness. Another liquidity-driven example involves companies tapping immediate liquidity through other forms of specialty finance, such as sale lease-back structures against real estate and equipment. With so many companies looking at depressed top lines due to the economic shutdown, the flexibility of the private markets may provide alternative solutions and structures for companies to generate cash.

When looking at sectors, we remain focused on resilience. Is the business model able to pivot and thrive post-COVID? Will cash flows remain robust? Where are the tailwinds post-COVID? How exposed is the business to market risks? Renewable power is one example of a resilient sector, as it is characterized by contracted cash flows and return drivers—such as how much the wind blows or the sun shines—that have limited correlation to other market factors. Digital infrastructure is another sector with contracted cash flows, and it is benefiting from the increased demand for data consumption and faster connectivity as working from home becomes the new normal. These new demands are also supportive of structured equity and debt investments in private technology businesses.

Regarding demand and supply, the dynamics in the secondary markets present a potentially compelling opportunity. In private equity, there’s just over US$100 billion in secondary dry powder, which sounds like a big number. But when you compare that to the $3+ trillion size of the private equity universe, you can see that there’s potentially a huge supply-demand imbalance. We think that’s going to lead to many interesting investment opportunities. Real estate secondaries are another example, and we see an even more pronounced supply-demand imbalance there. We’ll know more as June 30 valuations come into view, but we think the underlying dynamics are favorable for investors looking to capitalize on this space.

Mike Pyle
Global Chief Investment Strategist for the BlackRock Investment Institute
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Mark Everitt
Head of Investment Research and Strategy for BlackRock Alternative Investors
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Pam Chan
CIO and Global Head of the Alternative Solutions Group
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Alan McKenzie
CIO for Family Offices
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