UBS: Consider private markets in a low-yield environment

How can investors deal with this dynamic? One option for long-term oriented investors to consider is allocating capital to private markets. These investments, which include private equity, private debt, and private real estate, require tolerance for significant illiquidity. This is necessary given the unlisted nature of the assets they target, which range from startup companies to distressed firms to buildings, and to provide fund managers with time and flexibility to add active value. In return, private markets enhance portfolios through diversification and return premiums to compensate for the illiquidity.

Why private markets?

• Attractive returns in a low-yield, low-return world. Private markets have generated premiums to traditional asset returns over the long term. For example, pooled internal rates of return for US private equity over the 20 years that ended March 31 were 12.6%1. While not directly comparable, the S&P 500’s timeweighted return for this period was 8.0%. Against a backdrop of low yields and returns, our long-term expected returns of 8–12% for private markets are attractive in a portfolio context.

• Better risk-adjusted returns. Volatility and Sharpe ratios for private markets compare favorably to those of equities and bonds, so adding diversified private market exposure should enhance portfolios.

• Additional sources of return and alpha potential. Investing in non-traded assets requires a different approach and skill set. No continuous market or pricing exists, information is limited, and buying assets takes time. These inefficiencies are what make the opportunity set compelling. There is more potential for mispricing (and thus differentiated returns and manager alpha) because most investors simply don’t have the skill or patience to realize the true value of these assets. 

The rub is that successful investing in private markets requires expertise, tolerance for complexity, and a longterm mindset.

• Manager selection is critical. The gap between the top and bottom-performing fund managers is far wider than for equities or bonds. Investors must have access to top-quartile managers and a disciplined evaluation and selection process.

• Portfolio management is complex. It takes time and a strong network of relationships to build up diversified private market exposure. Funds are not always open and can be selective about their investors. Cash flow timing is unpredictable, as funds invest only as opportunities arise over multiple years and return capital as they exit underlying investments. Investors therefore must continually commit to new funds to maintain consistent portfolio exposure.

Mark Haefele
Global Chief Investment Officer
Wealth Management

Andrew Lee
Head of Investment Strategy – Alternative Investments
CIO Wealth Management Research – Americas

1 Cambridge Associates LLC.

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