Many investors with long-term horizons invest in longer-cycle asset classes such as private equity, infrastructure, real estate, and private credit. These private markets offer diversification and the potential for higher risk-adjusted returns, in exchange for illiquidity. An additional benefit is that private investments are often less volatile because valuations are performed less frequently (quarterly for the most part). As a result, private asset valuations are slower to react to market turmoil, including the turmoil that accompanied the COVID-19 crisis.
When pubic markets decline precipitously, institutional investors may experience “the denominator effect” – an increase in the private market portfolio as a percentage of the overall pool of assets – caused by a difference in valuation timing. See Figure 1.
In response to market turmoil, an investor’s initial instinct may be to stop or scale back private market investments in an attempt to right-size the allocation. Investors may also be tempted to sell assets in secondary markets – this is generally not advisable for illiquid assets in times of market stress.
State Street Global Advisors has decades of experience managing through multiple crises on behalf of our clients. There are several methods we employ to steer our clients’ portfolios through times of volatility:
Figure 2 plots inception-to-date Internal Rates of Return (IRRs) for global buyout funds from 1980 to 2016 and overlays recessionary periods in the shaded bars. Funds from 2017 onward were excluded, as they are still in the investment period and the results to date are not indicative of overall returns. Generally, the fund vintages launched in recessionary periods fared better than fund vintages launched in the periods immediately prior and post. For example, the 1998-2000 vintage funds had pooled returns of approximately 8-17% while the 2001-2003 pooled returns ranged from approximately 22-27%. Similarly, the 2005-2007 vintage funds had pooled IRRs of 6-10%, while the 2008-2012 vintage funds posted a 10-15% pooled return.
Our research suggests, therefore, that a potential for outperformance does exist for those investors with capacity to commit additional capital during the COVID-19 recovery period.
In sum, there are three takeaways for private market investors from our analysis of prior market crises.
1Assets under management.
2Past performance is not an indicator of future returns.
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