Adding private markets to DC pension plan portfolios
For decades, investments in private markets have been a performance driver for defined benefit (DB) pension plans. However, they have not yet been widely adopted as a component of an investment strategy for defined contribution (DC) pension plans.
At a point when DC pension plans are poised to overtake DB pension plans as the predominant pension system globally, this paper analyzes the potential benefits of adding private market investments to a DC pension portfolio.
Taking a theoretical approach, we first examine the effects that an allocation to private markets can have on the risk/return profile of a portfolio consisting of traditional asset classes.
We then set out to examine the potential impact a relatively modest allocation to private markets could have on an illustrative DC plan over a long-term time horizon. Using historical and forward-looking glidepath analyses, we illustrate how an exposure to private markets has the ability to improve the overall risk/return characteristics of a DC plan portfolio and potentially improve the monthly retirement income for beneficiaries by more than 15%.
Lastly, we touch on some of the structural reasons DC plans have historically been unable to invest in private market funds. We argue that most of these obstacles can be overcome today by private market investment managers, enabling DC beneficiaries the flexibility to access private market investments – an accretive portfolio allocation that DB beneficiaries have enjoyed in the past.
Private real estate: Why invest in Asia-Pacific?
A convergence of four key growth drivers — a flourishing middle-class, swelling consumer demand, rapid urbanization and strengthening domestic business growth — has transformed the private real estate landscape in the Asia-Pacific region.
Its rapidly developing cities are still experiencing growing demand for high quality office, retail and residential space, albeit with pockets of oversupply. Meanwhile, its mature metros are suffering considerable supply/demand imbalances across property segments. Astute real estate investors are afforded the opportunity to benefit from this transitional environment, as long as they have the depth of local knowledge to carefully navigate the nuanced and varied property markets in the region. Strategically, we believe three key areas of focus will yield the most compelling private real estate investment returns: buying quality assets below replacement cost in markets with strong fundamentals; buying, fixing and selling undermanaged properties in strong locations; or developing core assets and exiting to an increasingly large pool of core focused Asia-Pacific investors. Successful investors in the region have demonstrated their ability to generate attractive risk-adjusted returns, while historical correlations have validated the region's added value as a portfolio diversifier. As a result, competition for premier assets in the region has intensified as savvy domestic capital is increasingly competing with foreign investors in the hunt for attractive real estate yields throughout the region. In this research flash, we review the opportunity set that the Asia-Pacific region provides and consider strategic approaches to unlocking value across property types. Looking forward, the Asia-Pacific region is poised to continue to offer the globe's largest real estate investment opportunity set, and real estate investors must be equipped with local expertise in order to maximize the real estate return potential.
Private real estate: in search of the appropriate benchmark
Regardless of the asset class, the ability to generate superior investment performance is the measurement that separates good investors from great investors. In most asset classes, performance is easily compared and contrasted against a commonly agreed upon investment universe or an appropriate index of investment opportunities.
But in private real estate, investors face the dilemma of attempting to evaluate performance without the benefit of a commonly agreed upon benchmark.
Despite greater availability of private real estate benchmarks, absolute return comparisons continue to provide investors with the most pragmatic solution to benchmark the performance of their real estate portfolios. The absolute return benchmarking approach evaluates the return of a property over a certain period of time relative to a fixed target number and is a methodology with the significant advantage of simplicity.
In this Research Flash, we intend to raise investor awareness of alternative performance measurement methods and indices. We review the challenges investors face in performance measurement, compare the historical performance of public vs. private real estate indices and evaluate some of the key merits as well as the shortcomings of a number of the private real estate indices currently available to investors. Our goal is to help investors better understand the characteristics of the indices currently available to them and make more informed performance measurement decisions going forward.
Private equity: emerging markets – control is the key to success
In the past decade, emerging markets have attracted a greater level of interest and capital from investors in search of higher returns regardless of the higher level of risk.
Despite the strong growth resulting from the powerful long-term fundamentals in emerging markets during this time period, the returns generated by private equity firms have been largely disappointing. This is a consequence of too much capital inflow leading to excessive valuations and over-dependence on growth for returns. At the same time, many managers lacked the requisite skill set to steer companies through economic down cycles and create a sustainable growth trajectory.
Today, many institutional investors are questioning emerging markets. In contrast, Partners Group continues to believe the emerging markets story is a compelling one and that an allocation to emerging markets private equity is accretive to investment portfolios, given the sustainable and strong underlying fundamentals in these markets. Most of these economies continue to exhibit favorable tailwinds, including the attractive demographics in younger economies in Asia, Latin America and Sub-Saharan Africa. Governments in several larger economies, such as India and China, have also been introducing positive structural and regulatory reforms to create a more conducive investment environment for the private sector. These trends support our conviction that emerging markets will continue to experience higher growth relative to developed markets, while market opportunities requiring private capital will remain abundant.
However, the private equity landscape in emerging markets has evolved significantly in terms of scale, quality, and complexity. Partners Group has seen the emergence of more control-oriented transactions requiring active ownership and a different skill set to help drive change in companies and play a pivotal role in value creation. This compares to the previous prevalence of often rather passive, minority investments in fast-expanding, founder-led companies, driven by the need for expansion rather than transformational capital and requiring little expertise on the part of the manager. These deals were constrained firstly by the relatively new concept of private equity in many emerging markets and secondly by regulatory barriers restricting foreign ownership in certain sectors. While the arguments in favor of growth investing continue to hold true for newer markets such as Indonesia, Vietnam, or Colombia, Partners Group sees new themes emerging in the more mature developing economies such as China, India and Brazil, which lend themselves well to more control-oriented transactions.
As investment opportunities continue to evolve in size and complexity, the need for private equity firms to have sufficiently built-out resources, strong operational expertise and deep, local networks becomes all the more important if they are to implement the necessary value creation initiatives. Today, Partners Group still believes most managers in emerging markets do not have the requisite skill set to capitalize on these opportunities. In such an environment, investors themselves need to navigate carefully between those firms that are skilled enough to succeed and the firms that are not.
Private real estate: opportunity in Europe’s real estate debt markets
Financing real estate investments in European markets remains a challenging endeavor. The retrenchment of bank lending as a result of the financial crisis, stricter lending requirements and the subsequent enactment of regulatory reforms has made financing unavailable to all but the most secure borrowers.
Yet the market has simultaneously created new demand for non-traditional debt lenders to fill the gap. Europe’s bank deleveraging activity is estimated to create a USD 163 billion gross funding gap where alternative lenders are currently finding opportunity. These real estate debt opportunities can provide investors with attractive core-like returns while providing an attractive position in the capital structure with adequate downside protection provided by equity cushions. In this research flash, we seek to identify opportunities of the European real estate debt markets and where investors should be focused on in order to benefit most from this window of opportunity.