For long-term investors, private markets continue to be an attractive asset class. These assets provide return enhancement, increased diversification and the ability to invest for positive societal impact. However, many investors remain under-allocated to this area.
We believe having an allocation to private market strategies will lead to better outcomes for charitable portfolios, while gaining access to unique opportunities that strongly align with the long-term investment horizon while contributing to better societal outcomes.
Allocation to private market strategies
In our experience, while many charities and endowments have diversified portfolios, they are under-allocated to private markets and should be looking to right-size this position.
As we discussed in our previous article, charity portfolios continue to have a heavy reliance on public equities. While returns have been strong, the number of stocks available in public equity markets has been steadily declining and the market has become far more concentrated. Alongside public equity, we encourage charities to consider having a strategic allocation to private markets, perhaps from 5% to 20% (or even higher). This will provide a more resilient portfolio, delivering better diversification and risk protection, improving sources of return and contractual income.
One of the challenges for charities is navigating the wide range of available opportunities and funds within private markets. It can be overwhelming, and that’s where we can help. Private markets cover a wide range of strategies but at a high level we tend to group them into private equity, infrastructure and private credit, and we see opportunities in all of these areas.
Where private market opportunities lie
We see a number of attractive opportunities within private markets, both on the credit and equity side, which charities as long-term investors should be taking advantage of.
Infrastructure has been an area of focus for some time, and remains an asset class we favour. Many of these strategies look to deliver returns of 10-12% pa net of fees. We particularly like infrastructure funds focused on developing “greenfield” – or new – energy transition and renewable energy assets. That entails development and construction of projects such as offshore and onshore wind, solar photovoltaic (PV), pumped storage hydro, transmission and battery storage, thus creating a significant and tangible impact on net zero goals as they bring new clean power generation online.
We view private equity as attractive, too – there are a multitude of different strategies which sit at various points on the risk-return spectrum, ranging from venture capital through to mature company buy-out and secondary funds.
Venture capital is often complementary to charitable objectives such as healthcare, life science and biotech innovations, which support breakthrough research and the development of vital new technologies. We see these types of venture strategies acting as a good satellite allocation for investors who have established private equity allocations.
For those who are looking to initially allocate to private equity, we suggest buy-out and secondary-focused funds. Finally, we see tremendous opportunities for investors in private credit, which offers both diversification and resilience in the current environment. Private credit is simply debt which is not traded publicly. We are seeing many innovative solutions here which support the growth of SME businesses and key sectors.
As one example, we worked with an asset manager in developing an asset-based lending strategy where each of the underlying loans was aligned to the UN sustainable development goals.
We know impact-focused investing is a key focus for many charities and endowments and these opportunities can deliver on that. Not only do these opportunities play a key role in supporting positive societal change but they also deliver long-term financial returns charities require.
For us, it’s about helping charities access these opportunities that deliver both returns and measurable positive outcomes.
Implementation is critical
Setting and agreeing on a strategic allocation to private markets is only the first step. Implementation is critical, and not getting this right, for instance manager selection, could have a big negative impact on returns.
We understand that investors have shied away from having an allocation to private markets, because for many it seems a very daunting challenge to implement. That is a common misconception and is why we help charities with a thorough and structured approach to ensure they are in the best position to make informed allocation decisions and implement the opportunities we outlined above.
This includes working together to develop the long-term strategic objective of the programme, target allocations, and annual tactical investment plan. We then assist with manager selection and implementation. This is critical as the performance gap between top-quartile and average managers is significant. Finally, ongoing monitoring is important to ensure alignment with objectives.
Take advantage of the opportunities presented
Charitable portfolios have a very important role to play to help deliver on the charitable objectives set by the organisations. Now while these portfolios tend to be diversified, this diversification is primarily within public markets. Thus, the portfolios are not as resilient as they could be and are missing out on opportunities such as the ones discussed above.
In our view, charities as long-term investors should revisit their strategic allocations in order to take advantage of the opportunities available in private markets. These investments diversify sources of return, provide stable income and make portfolios more resilient.
Jennifer O’Neill is head of not-for-profit investment and Jeffrey Malluck is associate partner at Aon
