Making private markets work in a barbell strategy

Institutional investors have become accustomed to low yield in some areas of fixed income they have historically depended upon. This is hardly news, and Invesco’s 2021 Long-Term Capital Market Assumptions  anticipates that yields are likely to stay low. This expectation and investors’ need to meet return objectives in a challenging environment are driving a trend of investment “barbelling,” a not-so-new concept that has been reconsidered, reimagined, and recast to face the challenges confronted by today’s institutional investors.

The barbell concept – a portfolio construction that focuses roughly half of allocations on near-term tactical investments and the remaining half on longer-term assets – is familiar to most investors, but effectively implementing this approach is not as simple as the visual image it calls to mind. It requires substantial investment expertise and resources, but it’s a hot topic at the moment because it allows for tremendous flexibility and the incorporation of two things that institutions find very appealing: private market investments and next level, customizable index investing that seeks returns beyond while also reducing costs (and perhaps contributing to the risk budget allocated to private markets).

Alternatives: Critical for growth optimization and income

In 2019, private market asset capitalization grew to nearly $6 trillion USD,¹ a clear a sign as possible that with traditional public assets burdened by underwhelming return expectations institutional investors are looking for alternatives in every sense of the word. The huge surge of institutional capital is flowing into increasingly complex and nuanced private markets that are anything but standardized – but that does not deter investors, nor should it, says Neil Blundell, Head of Global Client Solutions, Head of Alternative Solutions, Invesco.

“If you have an ability to allocate capital to longer-term private market investments, that’s where – across the board – we see a substantial pickup in expected returns relative to traditional asset classes,” Blundell says. “You can potentially tap into more growth, more income, and more diversification. But it’s a whole new world in private markets compared to the days when there were only a few sub-sectors. The private markets landscape has become increasingly complex in terms of the sub-strategies, and asset growth has been exponential. The challenge is that you need significant staff, technology, and infrastructure to effectively navigate the alternative space.”

“Our mantra is to be an extension of staff for the institutional investor. We don’t want to take over. If you’re the head of alternative investments at an institution anywhere in the world, we want to help you invest smarter by providing better research, analytics and access so you can invest like one of the world’s largest institutions."

-Neil Blundell,
Head of Global Client Solutions, Head of Alternative Solutions, Invesco 

As the private market space has grown and matured, a multitude of investment opportunities have emerged that may potentially provide attractive risk-adjusted returns and help investors meet a range of objectives. These opportunities include matching liabilities and allowing for more stable cash flows – if investors can effectively access them. The largest institutions may have the staff and resources to comfortably play in private markets, but for other (read: most) institutions, it might appear at first glance to be a bridge too far in terms of time, capacity and human resources. 

“If you’re a mid-sized institution, it’s likely that you are under-allocated to private markets,” says Blundell. “You know it could potentially improve your overarching risk and return profile. But do you have what you need to set up the right asset allocation? Can you access, source and perform proper due diligence on high quality investments? How do you get economies of scale? How will you evaluate opportunities like co-investments, which may reduce the cost of ownership? On top of that, you’re going to need consolidated reporting, monitoring, and risk management for more complex, private investments. Simply put, private markets are not as straightforward to access as the traditional markets.”

Investors are under-allocated and sub-optimized in private markets

Blundell and his Investment Solutions Team at Invesco are constantly pursuing and refining solutions for what might be considered the democratization of private markets, or at the very least the process of creating a more level playing field for institutions of moderate and modest size. The process begins with a close look at investor’s existing portfolio in the context of the current market regime.  

“We start by using our technology to model the assets and liabilities of a client,” says Blundell. “Based on liabilities and cashflow needs, we may look at including additional alternative asset classes to the strategic asset allocation to see if we can improve the efficient frontier. We’ve done a lot of work to model these assets very specifically, so we can begin to quantify what it all means for a client in a very precise way. Typically, we find that most investors are under-allocated and sub-optimized in terms of the alternative asset class exposures within their portfolios, and they may have significant opportunities to enhance their asset allocation.”

It’s easy to envision how overwhelming an unaided venture into private markets might be when you consider the breadth and nuance across each private asset class, as well as region-specific considerations across North America, Europe, and Asia. To the new entrant into the private market space, the due diligence efforts alone may be enough to send heads spinning. Investors want to make informed decisions, of course, but for resource-constrained institutions, kicking off an effort to independently evaluate a new universe of prospective investments may be extremely challenging – and attempting to do so could very well lead to a suboptimal outcome without sufficient expertise in-house. On the other hand, by leveraging the possibilities of another trend sweeping the allocator universe – outsourcing some or all of the allocation process – investors can make private markets decisions leveraging the talent and resources available at a trusted partner, such as Invesco.

The essentials of being in the private market space – customization, exposures, reporting requirements, structuring advice – pile up in a hurry. International investors, for example, must navigate varied tax regulations, which may call for certain investment structures to be in place.

“We want to support our clients by providing the information they need in an understandable way so they can make decisions, and we can customize a solution for them based on those decisions,” says Blundell. “Our mantra is to be an extension of staff for the institutional investor. We don’t want to take over. If you’re the head of alternative investments at an institution anywhere in the world, we want to help you invest smarter by providing better research, analytics and access so you can invest like one of the world’s largest institutions. Our systems have modeled out private markets in a unique and specific way, which has taken a great deal of time and effort. We’ve invested significantly in our platform, which allow us to work seamlessly with clients to co-design and implement the most appropriate asset allocation for their unique objectives and constraints.”