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The irresistible allure of private assets

Public markets plummeted at the start of the pandemic. Investors like predictable short-term profits and strategic certainty. COVID-19 offered neither of these. By contrast, private assets offer a very different proposition. Here, endurance is rewarded. There is less exposure to the extreme emotional reactions that public markets experience over the short term.

April 12, 2022

First, let us explain what private assets are and what they have to offer. Private assets include buyout funds, private debt, private equity, venture capital, private real estate and so on. They are essentially any investment opportunity that is not available through public markets. Portfolio managers who invest in private assets aim to tap an alternative source of return that would not be possible if these assets were traded each day. They often look at the operational issues that, if solved, could benefit investors.

This might involve digitalizing the business by updating its IT systems. It might also require trimming down or refreshing a product range. Or it could involve shutting down a loss-making division or tilting the business towards more attractive sources of revenue.

The attraction of investing in private assets is that they are less exposed to the short-term volatility found in public markets. Although this makes these assets less liquid, portfolio managers that invest in them are usually more concerned about the fundamentals that support them. Their goal is to unlock the value and growth potential of these investments over the long term.

Investors are already increasing their allocation to private assets

According to the 2021 CIO Sentiment Survey produced by top1000funds.com, many institutional investors are increasing their allocation to private assets. According to these survey results, investors now appear more willing to pay an illiquidity premium and lock up their cash for longer in private assets.

There have been two powerful factors driving investors towards private assets over the past decade. The first includes the changes experienced in the way investors construct portfolios. The second centers on the huge improvements made in regulatory infrastructure, particular in leading jurisdictions such as Luxembourg.

The rise of risk premia investing

Investors have been shifting their focus away from traditional asset allocation for some time. Many are constructing their portfolios using individual sources of risk premia rather than focusing on broader traditional asset classes.

Extraordinarily low interest rates have driven this trend as they have flooded public markets with liquidity and created significant asset price inflation across asset classes. Subsequently, returns between asset classes have become more correlated, reducing the diversification benefits from traditional asset allocation. This has led investors to seek alternative and less correlated sources of premia, which has driven them towards private assets.

The advances made in fund infrastructure

Another reason why investors are more willing to invest in private assets is because the regulatory environment has evolved and, consequently, fund infrastructure has improved. It has made private assets much more attractive to institutional investors.

Luxembourg is an interesting example. Huge changes have been made to Luxembourg’s fund infrastructure for private assets, driven predominantly by changes in the European regulatory framework. Subsequently, Luxembourg’s regulator has now authorized over 267 alternative investment managers (abbreviated AIFMs), while 600 have been registered.

Real estate, private equity and private debt have since all experienced a significant increase in assets under management. Real estate experienced 7.2% growth in 2020, bringing its total assets under management to €88.2 billion. Meanwhile, private equity has seen its own assets under management grow to EUR 148 bn, equating to 19% year-on-year growth as of the end of September 2021. Private debt over the same period has climbed 14.5%, increasing its assets under management to over
EUR 56 bn.¹

Investors are shifting their allocation towards private assets

Investors are shifting their allocation towards private assets
Source: 2021 Sentiment Survey, top1000funds.com

These improvements in regulatory infrastructure have meant that there is now far more choice and transparency for those investing in private assets. Fund providers can launch products faster to market using the various regulatory structures and benefit from the European passport introduced by the Alternative Investment Fund Management Directive (AIFMD).

Specialized Investment Funds (SIFs) are one such example. These are typically used for real estate and private equity funds and are approved by the regulator.

Reserved Alternative Investment Funds (RAIFs) are another example. Here, the fund is not regulated, but the manager running the fund is. One of the attractions of this type of structure is that regulated managers can launch funds much more quickly than if they use an SIF structure.

Luxembourg offers a wide range of investment vehicles

Life expectancy at birth and the gender pension gap in OECD countries
Source: Alternative investment and private assets, Association of the Luxembourg Fund Industry.

* May be subject to AIFM Law.

Finally, there is the partnership structure, which reflects the traditional LP/GP structure, which is commonplace with private asset investing. These structures are, for instance, favored by Anglo-Saxon asset managers as they can easily replicate parallel funds they may have in Delaware. However, the structure itself is not regulated; by appointing a regulated manager you obtain the AIFMD passport and can distribute in Europe.

Final thoughts

The attraction to private assets has been driven by a combination of changes in the investment environment and better regulation. Technology has also played an important role, alongside innovative solutions that have made private assets much more accessible.

The future is bright for private assets. They fulfil a need and desire that investors have. The market is now far more liquid and more accessible than in the past. This has made the allure of private assets irresistible.

 

In the long run

Environmental, social, and governance (ESG) criteria dictate investor behavior around the world. Their priorities and preferences can shift very dynamically. Long-term principles for decision-making and well-founded investment solutions are more important than ever.

 

Daniela Klasen-Martin

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1 ALFI Real Estate Investment Funds Survey

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