Investing in private markets

Key Takeaways:

1. Interest in private markets is rising, but there is still scope to increase the allocation to private markets within traditional portfolios.
2. Private markets have historically amplified returns by offering unique opportunities that are not available in public markets.
3. Those new to private markets can consider a four step process, which starts with a liquidity budget and ends with funding from appropriate sources.

Private markets are becoming critical exposures for those seeking access to the whole market: the number of large private companies (those with 100+ employees) has grown by 46% over the past thirty years, while the number of public companies has shrunk by 24%.¹ Companies are also increasingly seeking out private funding: only 25% of the leveraged loan market is funded by banks today, vs. 72% in 1994.²

For those who are new to the space, questions abound: which private markets exposures are right for me? What’s the right amount of exposure? How do I choose between the vehicles? And how do they fit into a traditional portfolio?

The “optimal” allocation to private markets will depend on each investor’s goals and characteristics. Most notably, whether the investor is optimizing for long-term growth or income, and how tax sensitive they are.

Consider this four-step process as a starting point:

What are private markets?

Choose the right private market exposures based on portfolio objectives

Private equity and private credit are two of the most common private market exposures, but may be more appealing to different investors at different times. While both have delivered amplified returns vs. traditional asset classes over the past decade, we have noticed that private equity strategies tend to result in longer term returns while private credit strategies are more likely to deliver returns in the form of ordinary income.

Private investments have been able to amplify returns over the past decade
10Y average annual returns as of 12/31/24

Real estate and infrastructure – two other popular private asset classes – may offer a mix of capital appreciation and income. They may also offer some tax benefits that offset income distributions, such as pass-through depreciation deductions (though note the potential for recapture taxes upon sale).

Choosing the right private market exposures for your portfolio may come down to how you weigh different objectives. What’s more important: longer-term price appreciation or high levels of income? How important is tax efficiency?

Determine the size of your allocation, based on risk/return assumptions and liquidity budget

The second step is to explore sizing allocations. This will be partially a function of your expectations around risk, return, and correlations – and partially a function of your liquidity budget.

High expected returns typically lead optimization models to maximize allocations to private assets, so for many, liquidity needs will be the cap on private asset allocations.

Many investors over-index to liquidity – that is, they keep a higher portion of their assets liquid than they need to. But with the attractive returns and diversification properties potentially available in alternative strategies, it is worth considering how much of a portfolio really needs to be liquid.

In a recent advisor center poll, the majority of advisors (73%) shared that they allocate at least 5% of HNW portfolios (defined as $5M+) to private market exposures, with 29% allocating at least 10%.

Most advisors allocate a significant chunk of HNW portfolios to private markets
Poll responses to "what % of a $5M+ portfolio would you invest in private markets"

Compare that to the average family office surveyed, which allocates 42% of its portfolio to alternative assets.³

Choose the right vehicle

Private market investments come in varying flavors of liquidity: not all alternative investments are illiquid, and they may come with varying lockup periods. Traditional private equity investments could have 10+ year capital lock-ups, while private credit may have a 3-7 year investment horizon.

Those looking for additional liquidity could also turn to semi-liquid strategies, such as interval funds, that offer regular liquidity, or even daily-liquid mutual funds that employ hedge fund strategies.

Interval funds are generally structured as closed end investment companies registered under the Investment Company Act of 1940. Unlike traditional closed-end funds, interval funds do not offer daily liquidity and are considered illiquid, as they generally permit redemptions during periodic repurchase windows-typically on a quarterly basis. Interval funds may also be available to buy at lower minimums and lower suitability requirements. The risk, though, is that there can be limits to the amount of shares available to be redeemed each quarter – so investors using these vehicles should have longer liquidity horizons than the quarterly liquidity windows may otherwise suggest.

Fund private market exposures from traditional assets in a like-for-like manner

The last step is to appropriately source each private market allocation. The funding decision has a large impact on portfolio risk/return: we prefer to fund strategies with equity-like risk profiles from equities and bond-like risk profiles from bonds, but there isn’t always a like-for-like swap.

Sourcing higher-risk allocations from bond portfolios can increase the risk of the portfolio, while sourcing lower-risk allocations from stock portfolios could decrease risk, potentially also impacting expected returns.

Funding decision drives portfolio risk/return
Hypothetical 10Y historical risk/return

This generally means sourcing private equity out of public equity and private credit out of high yield bonds. The higher the risk and correlation to stocks, the more “equity-like” the asset is, while assets with low-to-negative correlations to stocks can be sourced from fixed income.

If there is no like-for-like swap – i.e., if the target asset is taking on more risk than bonds but not as much as stocks – you may need to source from a mix of traditional assets. Real assets, as an example, may be sourced from a mix of equity and fixed income assets within a portfolio, as might private credit when considering a higher quality fixed income starting portfolio.

Sourcing private exposures based on underlying characteristics

Building private markets into portfolios

The BlackRock Model Portfolio Solutions (MPS) and Multi-Asset Income (MAI) teams each run models that put this into practice. Portfolios with longer-term growth objectives may gear more towards private equity, while those with more current income needs may gear more towards private credit.

Sample 60/40 allocations with private markets:

Those with access to tax-advantaged accounts may also benefit from asset location strategies – or in other words, holding less tax-efficient asset classes in tax-advantaged accounts.

Adding private markets to your portfolio can help enhance diversification, provide access to unique opportunities, and potentially deliver higher returns. No matter where you are on your private markets journey, BlackRock is here to help.