Allocation to private markets: How private market investments can unlock new return potential

The private markets can hardly be described as an “alternative” asset class. Investors may even conclude that this asset class is more important than ever for a diversified portfolio. In fact, private market investments already play an important role in the portfolios of many institutional investors. The BlackRock Investment Institute (BII) is convinced of this, and uses its own analyzes to provide portfolio managers and BlackRock customers with important insights into the investment markets.

The BII assumes that adding private assets to portfolios of up to 20 percent can be beneficial for investors. Instead of a traditional 60/40 allocation in stocks and bonds, BlackRock experts recommend a mix of 50 percent stocks, 30 percent bonds and 20 percent private market investments. Because the Great Moderation phase is over and the markets have changed. The current environment of higher inflation, higher interest rates and sluggish growth is noticeably different from the conditions of the last 40 years.

The fact that we are dealing with a new market regime is clear from the relationship between publicly traded stocks and bonds: in the 40 years up to the end of 2021, investors could rely on stocks and bonds being negatively correlated, that is, in opposite directions Directions moved. Investors could therefore rely on these two asset classes for portfolio diversification and reliable sources of returns. On the other hand, a positive correlation between stocks and bonds means that their returns move in the same direction. If this is the case, they no longer reliably serve as a diversification and source of return, especially if they simultaneously lose value. That’s exactly what happened in 2022, when investors in both stocks and bonds suffered losses.

Different options

Private market investments include private equity, infrastructure, private credit and real estate. They are traded on the private markets and less frequently than is usual for listed stocks and bonds. Private market investing helps investors expand their options and improve their return potential and portfolio diversification. Some of them also offer inflation protection.

Private equity – investing in privately owned companies. This asset class offers the opportunity to invest in corporate spin-offs, public-to-private transactions, distressed companies and failed sales in addition to traditional buyouts. In the current environment, we see interesting opportunities for companies that want to concentrate on their core business by spinning off parts of the company. Following the stock market correction, we also find public-to-private transactions attractive, as well as consolidation strategies that are used when smaller companies come under pressure.

Infrastructure – Investments in or loans for infrastructure projects such as toll roads, power plants or utilities, where investors receive a portion of the proceeds. In its Transition Scenario, the BlackRock Investment Institute estimates that capital investment in the energy sector will increase to an average of $4 trillion per year by 2050. Currently, the investment volume averages $2.2 trillion per year (source: BlackRock report “Sustainable and transition investing,” July 2023). In times of higher inflation, infrastructure assets tend to perform well, which makes them particularly attractive in the current environment of strong price increases.

Private credit – loans granted directly to companies, where the contractual terms and conditions are negotiated individually. Private credit can offer higher interest rates and better protection against losses than comparable bonds. Because many of these loans have variable interest rates, they can potentially generate high ongoing income even in times of rising interest rates. In our opinion, private credit is now one of the most attractive private market segments, offering significantly higher returns compared to public markets and better protection for investors. In an environment of sluggish growth, stubbornly high inflation and rising capital costs, the selection and quality of private credit investments are key.

Real Estate – Direct investments in first-class residential, commercial or industrial properties. Current valuations suggest that investors have a better opportunity to gain exposure to this asset class than at any time since the global financial crisis. We see good investment opportunities in the value-added segment in all regions worldwide.