The Case For Private Markets: Plugging The Gap

For a long time, public markets have been in what many have referred to as a Goldilocks period. Broadly speaking, growth has been occurring across most economies, market volatility has been low and inflation benign. On the surface, everything appears just right. But conditions are slowly shifting—and signs of change are afoot. For example:

  • Global growth is still pretty solid, but slowing in some markets
  • Inflation is low, but still present
  • Market volatility has increased of late

Many market participants are expecting future returns in publicly listed markets to be lower than in the past. Though it’s impossible to predict when, the prolonged economic cycle will turn at some point, which is leading many institutional investors to consider allocating to private markets. Why? We see three main reasons: 

  1. Diversifying risk;
  2. Seeking higher sources of returns from traditional investments, due to lower future return expectations, and;
  3. Preparing for rising interest rates.

Combined, we believe that these factors make private markets an attractive alternative to traditional asset classes.

A variety of plan types invest in private markets, which are particularly suited to investors with long-term time horizons and the liquidity budget to allocate to relatively illiquid assets. This includes endowments, hospital plans and other long-term pools. Pension funds have particular challenges that we believe could be offset by private-markets investing. Among them are that as return expectations for public investments decline, the net present value of a pension fund’s liabilities rise, leading to a potential funding gap. In addition, individuals are living longer today, which creates a longer tail to pension liabilities. Investing in private markets may help to mitigate these challenges.

Why else are institutions moving toward private markets? Because the investment opportunity set has changed.

In addition to the potential benefits of private markets and the signs of change in the current market backdrop, the investment opportunity set has changed over the last 20 years. Two significant differences from then and now are:  

  • 1.)The shrinking number of public companies—particularly in the U.S.; and
  • 2.)The dramatic reduction in credit provided by banks.

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Disclosure: Opinions expressed by readers don’t necessarily represent Russell’s views. Links to external web sites may contain information ...

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