Institutional Investors Allocating (More) to Alternative Investments

In recent years, many institutional investors have allocated portfolio dollars to alternative investments, and in particular to private assets. They are seeing evidence (for example, the most recent PitchBook Private Markets benchmarking report) that alternative investments generally, and private assets specifically, have the potential to outperform public markets and play a key role in institutional investors’ allocation strategies. Now, changes in market conditions are leading institutional investors to consider increasing their allocations to private markets.

Alternatives and Performance

Recent surveys confirm that institutional investors allocate broadly to alternatives, including private funds, and do so more often, and in greater amounts, than other types of investors. In its 2022 study of allocations to alternative investments by institutional investors, Fidelity Investments revealed that 86% of institutional investors invest in alternatives, allocating on average 23% of their portfolios to this class (with private equity the largest subclass, followed closely by real estate). By comparison, advisors allocate some 6% of their portfolios to alternatives. Fidelity believes that institutions focus more on alternatives because, among other reasons, those investors are focused on achieving relatively higher yields. Expected return data supports this position; Fidelity suggests that alternative investments may have higher implied real returns than the rest of the market generally (5.1% to 3.9%).

Alternatives and Changing Market Conditions

Institutional investors have good performance-based reasons to consider increasing their allocations to alternatives. Changing market conditions, in particular potential further inflation and rising interest rates, may provide another. One of the more prominent strategies being considered and implemented is increasing allocations to private markets and infrastructure to mitigate portfolio volatility and hedge against inflation. Many see private markets outperforming public markets, even when both face headwinds, as McKinsey notes about 2022. Some recent indicators that this shift is underway include the following:

• Seventy-two percent of investors plan to increase private asset and alternative investment allocations in 2023, according to Nuveen’s EQuilibrium institutional investor survey.
• Similarly, a strong majority of institutional investor respondents to BlackRock’s Global Private Markets survey plan to increase private allocations in 2023.
• Sixty-eight percent of global institutional investors surveyed by State Street plan to grow private investments in line with current targets.
• Top areas of interest for future investments — according to all three surveys — include the following:
  • Private equity
  • Private credit
  • Real estate
  • Infrastructure

Wild Cards

The denominator effect, or the manner in which a change in value in one part of an investor’s portfolio affects the rest of the portfolio, can also have an impact on private allocations, albeit a negative one when public markets suffer. A recent example: With public valuations experiencing sharp declines, investors in Asia and Europe found that they had met or exceeded their targets for private holdings as a share of their total portfolio, causing some to pull back from further private allocations.