As institutional investors increasingly turn to private markets in their investment strategies, a holistic approach is required to understand the opportunity set and optimize exposure, said Darren Spencer, director and client portfolio manager of alternative investments at Russell Investments, during a session at the Canadian Investment Review‘s 2022 Risk Management Conference.

Over the last 20 years, the number of private equity funds has increased by 650 per cent, with the private markets asset class representing nearly a $10 trillion opportunity set, he noted. “I think one of the key reasons why investors globally are increasingly attracted to private markets is this is no longer a niche asset class. . . . This asset class is really too big to ignore and there’s a lot of interesting opportunities for people to be able to tap into.”

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It’s paramount for institutional investors to invest in private markets across both time and sector, said Spencer, citing the differences in returns between venture capital and buyouts.

“Do you want to have a lot of exposure to venture capital, which is obviously going to help your returns? That’s been really one of the best performing parts of the private markets arena over the course of the last 10 years, but that hasn’t always been the case. Looking at buyout, the risk profile is different and returns tend to be more consistent.

“In addition, then you’ve got things like infrastructure and private credit which have differing return profiles again, so just be mindful of what the underlying risk and return characteristics are of those strategies and making sure that’s aligned with what your strategy is.”

He also suggested investors be aware of the dispersion of returns in private markets compared to public markets. “If you look at private markets, the dispersion between the top quartile manager and the managers performing in the bottom quartile, can be in the order of 30 per cent. Contrast that to traditional equity or fixing account managers with a spread between the top performing and the bottom performing managers, it’s maybe about 200 or 300 basis points. . . . It’s very important that [investors conduct] appropriate levels of due diligence, so you’re giving yourself the best opportunity, the best chance to invest in high performing managers.”

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Shifts in supply chains caused by increased geopolitical tensions will also increase investment opportunities in private markets, said Spencer. “This is going to be one of the key trends, we think, particularly over the course of the next 10 to 20 years as companies, particularly in North America, are going to want to bring their supply chains back to places like the United States, Canada and Mexico.

“That has really important implications and opportunities for specialist small- or mid-market buyout firms, particularly those focusing on [sectors such as] high-end manufacturing.”

And for institutional investors considering private credit, he noted, it’s important to focus on managers that are investing in sponsor-backed loans. “[If you get] a loan that starts to go wrong or there’s issues, the management teams [and] the operating partners are in a much better position to take remedial action and maximize the value of those investments and protect the interests of the lenders.”

Read more coverage of the 2022 Risk Management Conference.