CONTRIBUTORS
Tony Davidow, CIMA®
Senior Alternatives Investment Strategist
Franklin Templeton Institute
Priya Thakur, CFA, CAIA
Analyst
Franklin Templeton Institute
Preview
On average, 90% of the variability of returns and 100% of the absolute level of return is explained by asset allocation.
As Roger Ibbotson noted—and his research supports—the asset allocation decision is a critical determinant of the long-term success of an investment strategy. We have long recognized the value of asset allocation, but too often limited the allocation to traditional investments. With the democratization of alternative investments, driven by product evolution, advisors can now expand their asset allocation to include a broader array of asset classes to achieve client goals.
This paper considers asset allocation and portfolio construction, and the impact of adding private market securities to a diversified portfolio. We will use a series of case studies to illustrate how to allocate to private markets and show what impact they have on a traditional portfolio. This paper addresses the following:
- How do private markets fit within the goals-based investing process?
- What is the appeal of private markets?
- What is the value of developing an illiquidity bucket?
- How should advisors evaluate the risk-reward tradeoffs?
- What does the addition of private markets provide a diversified portfolio?
Key takeaways
In this paper, we have revisited the asset allocation and portfolio construction process and focused on incorporating private markets. We examined the role and value of adding these versatile and valuable tools to client portfolios and evaluated some of the unique due diligence considerations. We discussed the merits of developing an illiquidity bucket and how they can benefit investors.
With product innovation making private markets more accessible to a broader group of investors at lower minimums, and with more flexible features, more investors can now access these unique investments. In fact, depending upon the investor’s wealth, liquidity needs and appetite for risk, investors can diversify their exposure to private markets.
Lastly, we used case studies to illustrate the impact of adding private markets to a diversified portfolio. The cases help illustrate the versatility of private markets in increasing returns, increasing income, and decreasing volatility, and improving the likelihood of achieving specific investor goals.
WHAT ARE THE RISKS?
All investments involve risks, including the possible loss of principal. The value of investments can go down as well as up, and investors may not get back the full amount invested.
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The views expressed are those of the investment manager and the comments, opinions and analyses are rendered as at publication date and may change without notice. The underlying assumptions and these views are subject to change based on market and other conditions and may differ from other portfolio managers or of the firm as a whole. The information provided in this material is not intended as a complete analysis of every material fact regarding any country, region or market. There is no assurance that any prediction, projection or forecast on the economy, stock market, bond market or the economic trends of the markets will be realized. The value of investments and the income from them can go down as well as up and you may not get back the full amount that you invested. Past performance is not necessarily indicative nor a guarantee of future performance.
All investments involve risks, including the possible loss of principal.
Investments in alternative investment strategies are complex and speculative investments, entail significant risk and should not be considered a complete investment program. Depending on the product invested in, an investment in alternative investments may provide for only limited liquidity and is suitable only for persons who can afford to lose the entire amount of their investment. An investment strategy focused primarily on privately held companies presents certain challenges and involves incremental risks as opposed to investments in public companies, such as dealing with the lack of available information about these companies as well as their general lack of liquidity.
Private equity investments involve a high degree of risk and is suitable only for investors who can afford to risk the loss of all or substantially all of such investment. Private equity investments may hold illiquid investments and its performance may be volatile. The risks associated with a real estate strategy include, but are not limited to various risks inherent in the ownership of real estate property, such as fluctuations in lease occupancy rates and operating expenses, variations in rental schedules, which in turn may be adversely affected by general and local economic conditions, the supply and demand for real estate properties, zoning laws, rent control laws, real property taxes, the availability and costs of financing, environmental laws, and uninsured losses (generally from catastrophic events such as earthquakes, floods and wars). The value of most bond funds and credit instruments are impacted by changes in interest rates; bond prices generally move in the opposite direction of interest rates. Investing in lower-rated or high yield debt securities (“junk bonds”) involve greater credit risk, including the possibility of default, which could result in loss of principal—a risk that may be heightened in a slowing economy. Investments in derivatives involve costs and create economic leverage, which may result in significant volatility and cause the fund to participate in losses (as well as gains) that significantly exceed the fund’s initial investment in such derivative. An investment in alternative securities or vehicles which invest in them, should be viewed as illiquid and may require a long-term commitment with no certainty of return. The value of and return on such investments will vary due to, among other things, changes in market rates of interest, general economic conditions, economic conditions in particular industries, the condition of financial markets and the financial condition of the issuers of the investments. There also can be no assurance that companies will list their securities on a securities exchange, as such, the lack of an established, liquid secondary market for some investments may have an adverse effect on the market value of those investments and on an investor’s ability to dispose of them at a favorable time or price.
Hypothetical scenarios provided are not based on the performance of actual portfolios and the interpretation of the results should take into consideration the limitations inherent in the results of the models, some of which are listed below. The hypothetical models are based on historical performance of the market sectors reflected in the models, current market conditions, the amount of risk to be assumed by the portfolios, as applicable, and certain subjective assumptions relating to the respective investment strategies. Such model scenarios assume investment through the entire timeframe referenced. Hypothetical information is presented to establish a benchmark to assist in assessing the anticipated risk and reward characteristics of an investment or a strategy and to facilitate comparisons with other investments. In general, the higher modeled return is for an investment or strategy, the greater the amount of risk that is associated with that investment. Any modeled data or other forecasts contained herein are based upon estimates and assumptions about circumstances and events that may not occur or may change over time. For instance, the hypothetical models may assume a certain rate of increase in the value of the investment over a particular time period. If any of the assumptions used do not prove to be true, actual results may be lower than modeled returns or outcomes. The modeled outcomes are subject to change at any time and are current only as of the date herein. Hypothetical outcomes are subjective and should not be construed as providing any assurance as to the results that may be realized.
Any research and analysis contained in this material has been procured by Franklin Templeton for its own purposes and may be acted upon in that connection and, as such, is provided to you incidentally. Data from third party sources may have been used in the preparation of this material and Franklin Templeton (“FT”) has not independently verified, validated or audited such data. Although information has been obtained from sources that Franklin Templeton believes to be reliable, no guarantee can be given as to its accuracy and such information may be incomplete or condensed and may be subject to change at any time without notice. The mention of any individual securities should neither constitute nor be construed as a recommendation to purchase, hold or sell any securities, and the information provided regarding such individual securities (if any) is not a sufficient basis upon which to make an investment decision. FT accepts no liability whatsoever for any loss arising from use of this information and reliance upon the comments, opinions and analyses in the material is at the sole discretion of the user.
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