CONTRIBUTORS
Samir Sinha, CFA
Senior Analyst,
Franklin Templeton Institute
John Ivanac
Alternative Investments,
Institutional Relationships
Priya Thakur, CFA
Analyst
Franklin Templeton Institute
Preview
- Investors have become increasingly concerned about the liquidity profile of their portfolios given the significant growth in allocations to private investments, compounded by the heightened volatility and converging correlations of public investments.
- While exit and distribution activity have slowed down, there have been several important developments that suggest investors may be underestimating the liquidity available to them.
- The expansion of the secondaries markets, repricing of rates and innovations in fund structures provide new tools in the toolkit for investors to manage their liquidity profiles.
- Investors should reassess their liquidity models within the context of this new framework.
In part I, we highlighted that the levers around managing risk exposures in portfolios with significant exposure to private assets are evolving. This paper covers solutions to illiquidity in the private markets.
While understandable, the fears institutional investors harbor around meeting liabilities may not be as challenging as the environment would indicate. Exits will take a different path, and we believe higher and steady income can be found from private sources, which alleviates the necessity of fire sales of illiquid assets. The type of institutional investor (pension funds, sovereign wealth funds, etc.) does point to different desired levels of liquidity, but the expectation of higher volatility going forward (in rates, inflation, economy and capital markets) may not have as large an impact as many believe. Through reassessing asset-liability posture in this new regime and leveraging expanded liquidity facilitators and fund structures, we believe investors can optimize their private-market risk exposure and manage their liquidity profile with greater precision. Given this desire for optimization, our next piece will provide an analysis and framework for what a target allocation to privates should look like and show that there are examples of forward-thinking institutional investors who have actually improved their liquidity position through increasing their private allocation.
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.