Private Markets Outlook 2021
To illustrate how we implement our relative value views, we use both a return-focused and a yield-focused private markets portfolio. Both portfolios maintain an overall diversified approach and consider technical factors, such as deal flow, the breadth of asset classes, and incremental risk/return factors. The return-focused portfolio combines investment themes and segments of private markets with the potential for capital appreciation, while the yield-focused portfolio focuses on income-oriented opportunities. We calculate expected returns for the model portfolios using the five-year broad industry returns capital market assumptions from our Expected Return Framework and then apply asset-testing scenarios.
In our return-focused portfolio, we are overweight in private equity, where our allocations focus on direct investing, complemented by exposure to secondary and primary investments.
We also hold infrastructure as an overweight because of the proven resilience of essential services. Across the asset class, we see strong, long-term tailwinds (e.g. renewables) and actively avoid direct commodity price exposure. We are more cautious on real estate as we expect the effects of the pandemic to have a long-lasting impact on the market.
Finally, we underweight private debt in the return-focused portfolio. Post-COVID-19, we see better risk-adjusted opportunities in equity investments than in second lien because of the upside potential they offer. However, we retain flexibility to access opportunities in the secondary segment that may emerge from future distressed situations.
In the yield-focused portfolio, we favor first lien debt, where our focus is on established businesses with stable cash flows and high margins. These are often companies that have remained resilient during COVID-19 and are expected to continue to do so based on our thematic convictions. In general, we do not believe that the additional risk and higher loss rates in second lien and mezzanine are adequately compensated by higher spreads. However, we will selectively consider mezzanine and may buy into the junior debt of the most resilient businesses at times of material price corrections. We overweight infrastructure equity given the asset class’ contracted cashflows and ability to capture a recurring yield, and we avoid assets with significant GDP-linked exposure and high volatility or cash flows.