In nearly a decade, total global assets under management (AUM) have grown 118%, from $57.8 trillion in 2012 to $125.9 trillion in 2021, while over the same period (Exhibit 1) global private capital AUM has grown over 300%. As a result, private asset classes now represent 7.8% of global AUM, up from 4.2% in 2021.1 Notably, at the end of 2022, individuals represented only 16%2 of total private capital AUM, in significant contrast to their 50% representation of global AUM. Nevertheless, some analysts3 expect a potential shift in market share over the next ten years as individuals increasingly look to private markets following a period of elevated volatility, and changes in the investing landscape that have led to a Regime Change4, including:
Tectonic Shifts in the global geopolitical and macro environment. These structural shifts are putting pressure on the traditional 60/40 portfolio and driving the ongoing elevated correlation between stocks and bonds. Amid the resulting -18% performance in 2022, individual investors are increasingly seeking solutions to meet their needs for better diversification and returns.
A shrinking and more concentrated opportunity set in the public company universe. The number of firms listed on public exchanges has shrunk by ~30% over the past 40 years. As examples, there are 50% fewer public companies in the United States, 35% fewer in the United Kingdom, and 13% fewer in India5. In addition, the stability of future returns in equity markets may be at risk amid the concentration of technology stocks. Tapping into Private Markets may broaden the investable universe and unlock return potential for investors, as an increasing portion of value creation and return generation is taking place prior to companies going public.
Expanded access for individual investors. Until recently, Private Markets investing for individuals has largely been limited to the highest end of the wealth scale due to structural barriers including regulation, minimum ticket size and liquidity constraints. Globally, the average individual allocation to Private Markets Alternatives sat at roughly 3% at the end of 20226 versus nearly 40% for many US endowments7. Since then, innovative fund structures and technology solutions, including the introduction of evergreen vehicles for Private Equity and Infrastructure with lower minimum requirements, have broadened access. Moreover, this evolution is occurring as many retiring baby boomers or career switchers are moving their retirement savings out of defined contribution plans or other employer-sponsored plans such as 401(k)s into individual retirement accounts (IRAs).8 IRAs allow for much greater individual investor control of investment decisions, including investing in Private Markets.
Importantly, there is no cookie cutter approach to Private Markets investing as goals vary by age, sources of income, life circumstance and a myriad of other personal considerations. In this piece, we share our proprietary models for integrating Private Alternatives to achieve three primary investor objectives:
1. Generate Income: We believe incorporating Private Credit, Private Infrastructure and Private Real Estate can increase the income potential of the portfolio while maintaining substantial levels of liquidity. As detailed in Exhibit 10, with a 30% combined allocation to private Alternatives10, the “Generate Income” model portfolio would have yielded 5.7% annually versus 4.1% in the 60/40 portfolio.
2. Preserve Capital: Incorporating Private Credit and Private Infrastructure into a portfolio can provide downside protection11 and enhance inflation hedging benefits. Versus the 60/40 portfolio, our “Preserve Capital” portfolio would have lowered the standard deviation from 13.5% to 11.1%, increasing the certainty on the future value of the portfolio, given the tighter range of outcomes.
3. Boost Return: Incorporating Private Equity may significantly boost the performance potential of the portfolio, resulting in an additional 1.1 percentage points of return, from 9.1% to 10.2%, on a compound annual growth basis. One hundred dollars invested in the “Boost Return” portfolio in 2010 would be worth $343 today, versus $283 in the 60/40 portfolio.
Finally, understanding cash management is critical to successful implementation. Herein we share a framework for liquidity management involving two important steps – segmenting illiquid and liquid assets – and mapping Private Markets investment funding and harvesting expectations. Underlying Private Markets assets are illiquid, i.e., not easily converted into cash. As a result, each portfolio should be separated into illiquid, comprising the private alternatives allocation, versus liquid assets, which would include cash or “liquid wealth” to fund near-term cash flow needs, such as those to fund lifestyle expenses or significant withdrawals. Thereafter, understanding expectations for the pace and level of funding versus harvesting investments by asset class e.g., whether a “J-curve” exists, will aid overall liquidity management.
EXHIBIT 1
The Rise in Allocation to Alternatives
Special Collaborator
Racim Allouani
Acknowledgements
Henry McVey, General (Ret.) David Petraeus, Dan Pietrzak, Eric Mogelof, Vance Serchuk, Doug Krupa, Frances Lim, Josh Metz, Meghan Jacobson, Rebecca Ramsey, Fitz Robertson, Shannon Rutter and Ezra Max.
1 Bain, McKinsey, KKR GBR analysis.
2 “Why Private Equity Is Targeting Individual Investors”, Bain & Co, February 27, 2023.
3 Bain, McKinsey, KKR GBR analysis. “Why Private Equity,” Bain & Co.
4 Our colleagues Henry McVey and Racim Allouani have written a series on the new macroeconomic regime characterized by higher inflation, higher nominal interest rates, and lower real economic growth relative to long-term averages. In the series, the authors describe the need for institutional investors to rethink portfolio construction in the new regime. See “Regime Change: Enhancing the ‘Traditional’ Portfolio”, “Regime Change: The Role of Private Equity in the ‘Traditional’ Portfolio”, “Regime Change: The Changing Role of Private Real Assets in the ‘Traditional’ Portfolio”, “Regime Change: The Benefits of Private Credit in the ‘Traditional’ Portfolio” for full details. No representation is made that the trends depicted or described will continue.
5 Data available as of 2019. World Bank.
6 Cerulli Associates.
7 2022 NACUBO-TIAA Study of Endowments.
8 Cerulli Associates, https://www.cerulli.com/press-releases/ira-assets-reach-nearly-14-trillion.
9 Prudential, https://www.prudential.com/financial-education/ira-vs-401k
10 See Regime Change: Enhancing the ‘Traditional’ Portfolio for more information.
11 Downside protection is no guarantee against future losses