“Private investments, particularly private equity (PE) and venture capital (VC), have provided the strongest relative returns for decades, and top-performing institutions have been long-time allocators to private investment strategies, reaping the benefits of the outperformance.”
“Cambridge Associates’ past analysis indicates that endowments and foundations in the top quartile of performance had one thing in common: a minimum allocation of 15% to private investments”
These are the key findings of a recently published Cambridge Associates (CA) report.
Private investments include non-venture private equity, venture capital, distressed securities (private equity structure), private real estate, private oil & gas/natural resources, timber, and other private investments.
The Cambridge Report suggests a weighting of higher than 15% to private investment may be prudent: their analysis highlighted that top decile performers have higher allocations to private investments and that this allocation has grown over time to a mean allocation of 40%.
CA emphasis with proper diversification the risks within private investments can be appropriately managed. Nevertheless, they highlight there is a wide dispersion of returns in this space, as there are across Alternative strategies in general.
A critical issue, as highlighted by CA, was liquidity calculations, “investors should determine their true liquidity needs as part of any investment strategy”.
Liquidity should be seen as a “budget”. An investment strategy should be subject to a liquidity budget. Along with a fee and risk budgets.
CA emphasis that in relation to Family Offices “the portion of the portfolio needed for liquidity may be much lower than their allocation to illiquid investments would suggest.”
As CA notes, many of the top-performing Funds have figured out their liquidity requirements, allowing for higher allocations to illiquid investments.
CA conclude “Those willing to adopt a long-term outlook might be able to withstand more illiquidity and potentially achieve more attractive long-term returns.”
The Institutional Real Estate Inc article covered the CA report and had the following quotes from CA which helps to provide some context.
“Multi-generational families of significant wealth are often well-aligned for considerable private investment allocations,” said Maureen Austin, managing director in the private client practice at Cambridge Associates and co-author of the report. “The precise balance between the need for wealth accumulation for future generations and typically minimal liquidity requirements puts these investors in a unique position where a well-executed private investment allocation can significantly support and extend their legacy. Higher returns, compounded over time in a more tax-advantaged manner, make a sizable allocation to private investments quite compelling.”
“The long-term time horizon that comes with private investing aligns well with the time horizon for multi-generational families and is often central to our investment strategy with each family……”
Although the CA analysis does not look at the New Zealand market, it does highlight that those Funds underweight private investments are missing out.
With regards to New Zealand, Kiwisaver Funds are underweight private investments and Alternatives more generally.
Given the overall lack of investment to private investments and alternatives by Kiwisaver Funds, do they overestimate their liquidity needs to the detriment of investment performance? Yes, quite likely.
It is also quite likely that a number of New Zealand Endowments and Family Offices do as well.
There is no doubt that Alternatives are, and will continue to be, a large allocation within more sophisticated investment portfolios globally.
As Prequin note in their recent report, investor’s motivation for investing in alternatives are quite distinctive:
- Private equity and venture capital = high absolute and risk-adjusted returns
- Infrastructure and real estate = an inflation hedge and reliable income stream
- Private debt = high risk-adjusted returns and an income stream
- Hedge Funds = diversification and low correlation with other asset classes
- Natural Resources = diversification and low correlation with other asset classes
For those wanting a discussion on fees and alternatives, please see my previous post Investment Fees and Investing like an Endowment – Part 2.
As this blog post notes, a robust portfolio is broadly diversified across different risks and returns.
Increasingly institutional investors are accepting that portfolio diversification does not come from investing in more and more asset classes. This has diminishing diversification benefits.
True portfolio diversification is achieved by investing in different risk factors that drive the asset classes e.g. duration, economic growth, low volatility, value, and growth.
Investors are compensated for being exposed to a range of different risks. For example, those risks may include market beta, smart beta, alternative, and hedge fund risk premia. And of course, true alpha from active management, returns that cannot be explained by the risk exposures outlined above. There has been a disaggregation of investment returns.
Not all of these risk exposures can be accessed cheaply.
The US Endowment Funds and Sovereign Wealth Funds have led the charge on true portfolio diversification with the heavy investment into alternative investments and factor exposures.
They are a model of world best investment management practice. Much like New Zealand’s own Sovereign Wealth Fund, the New Zealand Super Fund.
Global Investment Ideas from New Zealand. Building more Robust Investment Portfolios.
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