Private markets continue to be a destination of choice for institutional investors to potentially achieve higher returns through capital appreciation and attractive yields. One of the biggest challenges is managing the liquidity that comes with private market allocations. The confluence of pandemic and war-fueled liquidity demand coupled with inflation concerns has triggered a review of clients’ liquidity management for private markets — how to maintain exposures, reduce cash drag, meet capital calls and adhere to asset allocation policies. Recently there has been an increased focus on more liquid strategies that have inflation-sensitive characteristics such as real assets.
This article is the second edition in a series about liquidity management for private markets. Over the long term, real assets play a complementary role within a total portfolio as a source of diversification, potential return enhancement, and risk reduction; they also provide a meaningful source of income. Real assets encompass a wide-ranging group of assets such as real estate, infrastructure, and natural resources, and are accessed through both private and publicly listed securities. Currently, they are playing a larger role in asset allocations as investor policy goals and objectives are being challenged by the effects of an inflationary environment not seen in four decades — an environment that is influencing changes in the forecasted returns of all assets.
Role of Real Assets with Private Asset Exposure
Publicly listed real assets are increasingly being used in conjunction with private assets in a completion role, providing exposure-management benefits such as the maintenance of policy strategic weight objectives at the top level across the total portfolio, within the real asset exposure, and with specific underlying assets. Additionally, real assets provide daily liquidity for the management of capital calls or distributions from private managers and ease demands on, or disruptions to, the non-alternatives portion of the total portfolio. Using indexed strategies tailored to client-specific needs, publicly listed real asset solutions can be implemented in a transparent, cost-effective manner.
Figure 1: Attributes of Publicly Listed Real Assets
Completion & Exposure Management
Minimize Portfolio Distruptors
Maintain total portfolio strategic allocation
Closley align real asset exposures
Manage capital call/distributions
Access daily cash flow capabilities
Reduce reral liquidity demand
on non-alternatives portion of total portfolio
Cost-effectively manage real asset
Source: State Street Global Advisors.
The private market for real assets is diverse and mature, with an estimated $3.5 trillion in assets and growth forecasts for 2022 of over 15% for infrastructure and close to 6.5% for real estate and natural resources.1 A large portion of real assets is accessible via private markets and provides an attractive risk and return profile. The group is led by commercial real estate, with core, value-add, and opportunistic investment approaches in both equity and debt securities across residential, office, industrial, retail, hotel, and other niche sectors. Similarly, infrastructure, focused on core, core-plus, and value-add approaches, has gained momentum recently and is projected to grow substantially — fueled by government-led initiatives and support — to add, expand, and update infrastructure to meet global demand and needs. Natural resources and their sourcing play a critical role in providing inputs for economic growth across the energy, mining, and agriculture segments.
The allocation and potential cash (“dry powder”) set aside by investors to satisfy commitments to private assets is quite significant today, at more than $1 trillion. This amount held by fund managers today is historically high and is structured to be invested in individually sourced investments over the course of the next five years. For private real estate, that number exceeds $400 billion, or roughly 30% of the aggregated total assets under management (AUM). Similarly, private infrastructure has nearly $300 billion to be invested, or roughly 35% of the AUM directed toward unlisted infrastructure. Private natural resources is in between the other two with close to $340 billion in cash on the sidelines, approximately 30% of the outstanding AUM intended for raw material assets.2
Soucre: Perqin Pro, September 2022.
Defined Benefit Plan Use Case
We will examine two use cases to illustrate real asset exposure. In our first case, a defined benefit plan has a dedicated real asset exposure outlined in its investment policy statement with allocations to real estate, infrastructure, natural resources, and commodities. The plan had some existing real estate private market investments, but wanted to expand to include other real assets in its policy mix. State Street Global Advisors worked with the plan sponsor to create a custom portfolio with underlying indexed assets and weights that matched the sponsor’s objectives and enabled them to gain immediate exposure to real assets. Private market allocations were anticipated to be made over the next three years.
Source: State Street Global Advisors, Representative example.
Additionally, State Street Global Advisors maintains the appropriate exposure across all the real assets through regular rebalancing, to provide liquidity for cash flows as needed for private market investments and to respond to broader total portfolio activity. Over time, the real asset mix was changed by the plan sponsor, and the custom solution made it easy to adjust the composition quickly, efficiently, and cost-effectively to maintain the exposure desired.
Endowment & Foundation Use Case
In our second use case, an endowment recently expanded its allocation to real assets and adopted a published real asset benchmark for internal tracking and evaluation purposes. The endowment anticipated making significant investments in private market real assets over the next three years but was looking for an exposure-management solution that would provide current exposure and liquidity in the interim. The published benchmark included a combination of publicly listed real asset equity and bond securities over a broad range of exposures.
Source: State Street Global Advisors, Representative example.
State Street Global Advisors collaborated with members of the client’s investment team to design a custom solution that tracks the benchmark using indexed strategies in commodities, global natural resources, and infrastructure equities along with core investment grade credit and natural resource bond exposures. State Street Global Advisors manages the custom solution against the benchmark through disciplined rebalancing and provides liquidity for the endowment’s expansion of its private asset allocation.
The Bottom Line
Real assets play an important role within a total portfolio as a source of diversification, potential risk-return enhancement, and inflation sensitivity; they also provide a meaningful source of income. Exposure and liquidity can be achieved via index strategies as individual components or as a multi-asset class custom solution. We welcome the opportunity to discuss your portfolio’s liquidity and exposure needs. Please contact us for additional information or visit ssga.com to view thought leadership related to liquidity solutions.
1Preqin Pro Database, 2022 Preqin Global Real Estate Report, 2022 Preqin Global Infrastructure Report, 2022 Preqin Global Natural Resources Report. 2Preqin Pro Database, September 2022
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