Within the private equity, private debt and private infrastructure asset classes, there are a range of investment strategies, each with its own risk-return characteristics and cash-flow profiles. The table below assesses how these investment strategies might rate against key investment objectives. For example, infrastructure debt offers stable, predictable cash-flows to fund investors, but low scope for investment returns beyond the running yield, whereas private equity – buyout offers high scope for capital gains but with lumpy, unpredictable cash-flows. Infrastructure’s core and value-add strategies offer diversification potential and some correlation of returns with inflation, since revenues are generally based on long-term contracts (sometimes inflation-linked) and relate to essential assets and services.
Investment strategies versus various investment objectives
NB: Assessments are for illustrative purposes only. Diversification potential is assessed against a portfolio comprising 50% global equities and 50% global government bonds. Inflation linkage assesses extent to which returns are correlated with inflation.
In further considering the risk-return characteristics of these various asset classes, Exhibit 3 below provides a sense of the return parameters – both in terms of the absolute level and the dispersion of returns – for these assets in comparison to public markets.
Illustrative dispersion of returns by asset class (2004-2016)
The chart shows the distribution of historical returns net of fees for each actively-managed fund category relative to its median performance. Bond and equity funds are represented by all US-domiciled funds tracked by Morningstar and hedge funds by the Thomson Reuters Lipper TASS global universe. Preqin’s global universe is used for private equity, real assets and private credit. Preqin data are internal rates of return.
The private capital investment model contrasts starkly with that applying for public investments, and many commentators hold this out as a source of alpha in itself. The fund manager in the private capital model plays a very different role to that of fund managers investing in public equities, generally leading the development of the value creation strategy to be executed by a portfolio business and then directing its implementation. The fund manager will be centrally involved in selecting and changing the management team and working with the team to deliver the strategy. See “Private Equity – an active investment model” (LPEQ, June 2017).
In summary, adding private capital to a traditional public markets portfolio through listed private capital can broaden the opportunity set (by providing access to assets and investment strategies not found in public markets), boost return potential, enhance yield, improve portfolio diversification and provide some protection against inflation. Listed private capital exists to enable public markets investors to invest in private capital through the stock market, thereby avoiding the regulatory and other barriers to access, as well as the complexity and illiquidity involved in undertaking private capital investment by the traditional limited partnership route.