CONTRIBUTORS
Samir Sinha, CFA
Senior Analyst,
Franklin Templeton Institute
John Ivanac
Alternative Investments,
Institutional Relationships
Priya Thakur, CFA
Analyst
Franklin Templeton Institute
Preview
Investors face a challenging question on liquidity
Over the past decade-plus, institutional investors have steadily increased their allocation to private assets in search of higher returns and higher yields. The fall in global public markets during 2022 unintentionally resulted in an over-allocation to private markets. Faced with a double-edged sword of higher interest rates and inflation, institutional investors are now concerned about their high allocation to private markets, which may impact their ability to meet their cash flow needs and their ability to hit their return bogies going forward. With higher-than-target inflation and elevated interest rates, the need to generate higher real returns is amplified. However, private market strategies provide divergent opportunities as they are exposed to different risks at varying magnitudes—and at differing points of the market cycle. Private market assets can actually provide more income and liquidity than many investors expect. We believe both the liquidity and cash flow generation of these assets are likely understated, while at the same time the dire situation around liabilities may be overstated.
This paper covers:
Liquidity requirements and optimizing the investment allocation
Current environment for liquidity in private markets
Given the backdrop, institutions are facing a difficult conundrum. They are wary of retaining such a high proportion of their capital within private market strategies—and concerned about making further commitments to them in the near future. Asset owners also expect their potential liabilities to spike in the current environment. In an environment where valuations have become more attractive, investors are also anticipating receiving capital calls from their general partners who expect to commit to new investments at these better valuations. Moreover, data suggests that investment periods which follow dislocations present compelling, higher-returning vintages for investors who can deploy capital during those periods.
WHAT ARE THE RISKS?
All investments involve risks, including possible loss of principal.
Private equity investments involve a high degree of risk and is suitable only for investors who can afford to risk the loss of all or substantially all of such investment. Private equity investments may hold illiquid investments and its performance may be volatile.
The value of most bond funds and credit instruments are impacted by changes in interest rates; bond prices generally move in the opposite direction of interest rates.
Investing in lower-rated or high yield debt securities (“junk bonds”) involve greater credit risk, including the possibility of default, which could result in loss of principal—a risk that may be heightened in a slowing economy.
An investment strategy focused primarily on privately held assets presents certain challenges and involves incremental risks as opposed to investments in public companies, such as dealing with the lack of available information about these companies. Additionally, an investment in private assets or vehicles which invest in them, should be viewed as illiquid and may require a long-term commitment with no certainty of return.
There also can be no assurance that companies will list their securities on a securities exchange, as such, the lack of an established, liquid secondary market for some investments may have an adverse effect on the market value of those investments and on an investor’s ability to dispose of them at a favorable time or price.