Private equity as part of a restructured portfolio

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When bond and stock prices fall, a greater allocation to alternative investments can improve portfolio performance.

A key tenet of the 60/40 portfolio construction model — 60 percent stocks and 40 percent fixed income — is that bond and stock prices tend to move in opposite directions.

For example, stocks are likely to perform better during stronger economic cycles, while bonds may offer some downside protection during tougher times. This strategy has served investors well for years. Between 2011 and 2021, the 60/40 portfolio produced an annual return of 11.1 percent.1

Traditional relationships changed fundamentally

Recently, however, this has suddenly changed. In the first six months of 2022, the Bloomberg US 60/40 index lost about 17 percent.2 The S&P 500 fell 20 percent during the same period.

On the surface, these declines appear to come from historically high valuation levels. Here’s how the S&P 500 fared in 20213 a 70-year record high, while German government bonds with maturities of ten years or more still showed negative yields in early 2022.4 However, this ignores the fact that changes in the economic and monetary environment have fundamentally altered the traditional relationship between stocks and bonds.

Investors turn to new markets

“High inflation, rising interest rates and great uncertainty are destabilizing the relationship between bonds and stocks,” says Pavel Ermoline, chief investment officer at Moonfare. “It undermines the effectiveness of the 60/40 model.”

Against this backdrop, investors are increasingly turning to private markets to add to their portfolios.

The place for private equity

Many of the larger institutions have been doing this for years, diversifying their pool of assets to expand their sources of returns. An analysis by Blackstone shows that pension funds allocate about a quarter of their allocation to alternative investments, while that figure is over half to endowments. By contrast, the share of alternative investments among private investors is only 5 percent.5

“The penetration of the wider investor market is slow,” says Ermoline. “Challenges such as lack of liquidity, barriers to entry and lack of information prevent some investors from realizing the full potential of a PE allocation even now.”

Many advantages

Addressing these challenges can enable investors to take advantage of the benefits that investments such as private equity offer as part of a balanced portfolio. These benefits include:

  • The potential for higher risk-adjusted returns. Private equity’s proven long-term return profile can prove highly beneficial in an environment of lower bond and equity returns. Research from Hamilton Lane shows that between 2000 and 2020, a rigid 60/40 portfolio produced an annual return of around 7.5 per cent. However, a portfolio with a greater allocation to private markets (42 percent public stocks, 28 percent bonds, 18 percent private equity, 12 percent private bonds) offered an annualized return of 9.40 percent.6
  • Greater diversification. Adding a private markets allocation to a portfolio means you cover a wider and more diversified part of the investment landscape. This spreads the risk at a lower level across the portfolio rather than being concentrated in one area. According to a study by Hamilton Lane, when select portions of private equity and private debt are added, a portfolio’s overall risk profile decreases.

“The private equity model makes a lot of sense during downturns because operational support is a key factor in weathering the storm,” says Ermoline. “As a result, many investors have already included more private equity in their asset allocation, demonstrating how this decision can deliver robust results over multiple cycles.”

  • You can read the entire article at Moonfare blog. There you will also receive useful tips for your entry into private markets.

Sources
1 gsam.com
2 bloomberg.com
3 axios.com
4 bundesbank.de
5 blackstone.com
6 hamiltonlane.com


Important Notice: This content is for informational purposes only. Moonfare does not offer investment advice. Please do not construe any information or other material as legal, tax, investment, financial or other advice. If in doubt, you should seek advice from an authorized financial advisor. Past performance is no guarantee of future returns. Your capital is at risk.


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