Yet, even when we talk to investors who tend to traffic in the private side of the market, many allocators still think about Alternatives more generically, as one asset class with similar attributes. Therein lies an opportunity to learn more and go one level deeper in our view. Indeed, as we detail in this paper, our firm belief at KKR is that each asset class is a separate and distinct component of the Private Alternatives universe, providing unique performance and diversification benefits to portfolios that warrant investor attention.
What are we hoping to accomplish? Our goal in writing this paper is to achieve the following:
- Reflect on the latest developments and trends for Private Alternatives. As detailed below, we still see significant opportunities across Private Equity, Infrastructure, Real Estate, and Private Credit. Importantly, there is a growing demand for private investments to solve a range of problems, including too much government debt, deconsolidation of the corporate sector, deleveraging in critical markets such as Real Estate, and increasing demand for retirement security for aging populations.
- Shed light on the different return, risk, and diversification characteristics of the leading Private Alternatives strategies and the role each could play in a well-balanced portfolio. In our view, too many sweeping generalizations have become normalized across the Private Alternatives industry. For example, including Private Equity in a diversified portfolio has vastly different benefits (and return/volatility profiles) than adding Private Credit. We believe that our research in this area, especially around portfolio construction, is particularly important for some of the newer growth segments of the market, including the individual investor, sovereign wealth funds, and insurance companies.
- Surface potential risks that could affect the Private Alternatives asset classes, and as such, where we think investors need to pay additional attention. Like marriage, investing in Alternatives is not something to be entered into lightly. Finding the right partner to help properly extract the entire value of the illiquidity premium is paramount, as the range of outcomes between the top and bottom quartile is great (Exhibit 103). Moreover, essential portfolio construction tools such as linear deployment, liquidity management, understanding concentration/exposure, and leverage are all prerequisites that an investor must consider. Simply stated, with Alternatives an investor is relinquishing some form of liquidity for a potentially higher return in the future. As a result, we think investors need to be thoughtful in determining their definitions of good value for the fees paid. Finally, regulatory risks and oversight should remain top of mind as this industry continues to grow and evolve. See Section II for details.
Looking at the big picture, we believe that we are at an inflection point in the Alternatives industry. Indeed, it reminds us of what happened when investors were clamoring for better returns in the 1990s and moved their capital out of more traditional bank trust departments towards more performance-based, independent money managers, many of whom became large mutual fund providers to the 401(k)s of today. It was – without question – a time of rapid change in the investment management industry.
In today’s world, we see such an inflection point ahead for both money managers and allocators of capital, particularly regarding longer-term private investment vehicles geared to the retirement savings market. Specifically, as private investments become more transparent and accessible, we think demand will only increase, as the asset classes can be important tools to help close the gap in retirement savings shortfalls (Exhibit 8). Moreover, this increasing need for better returns is occurring at a time when most developed market governments are not in a position to actually pay benefits to retirees through internal free cash flow.
There are other forces at work, too, that we believe will catalyze the change we are forecasting. For example, we think that the onset and fallout from COVID, including the huge swings that we saw in central bank policy along the way, served as an important accelerant in this journey. One simply needs to look at the traditional insurance industry, which allocated more towards Alternatives when the Fed and its peers suppressed rates to stimulate growth at the expense of existing savers. Interestingly, though, despite the 21 Fed hikes that followed COVID (and the subsequent surge in interest rates), insurers did not return to their traditional, pre-pandemic asset allocation. Rather, as one can see in Exhibit 12, insurers’ allocations to non-traditional assets have stayed elevated over the past two years (declining by only about three percent and still about double where they were in 2017). The reality is that more and more CIOs understand the longer-term benefits that private capital can provide.