Bigger private-market exposure found to bring higher overall returns

Moves by Asian institutional investors to raise their exposure to private-market assets in recent years may prove wise, if a study by investment consultancy Cambridge Associates is anything to go by.

The gap between top-performing endowment portfolios and the median has been wide of late, and a key indicator of better performance is a 15% or greater allocation to private investments such as venture capital, private equity and distressed assets.

That is the conclusion of Cambridge's analysis of 453 university, college and foundation endowments. The research found that endowment portfolios with 15% or more allocated to private investments have outperformed their peers consistently, over decades.

For the year to June 30, 2015, the MSCI World Index, which tracks the performances of large- and mid-cap companies across 23 developed countries, returned -0.32%. 

For the same period, the median return of the endowment universe was stronger: 1.3%. And looking only at endowments with 15%-plus in private investments, the median return was much better, at 3.6% (see first graph, left).

Not only did institutions with more than 15% in private investments outperform over the past five and 10 years (see second graph, below right), but they also outperformed by similar margins over 15- and 20-year periods, noted Philip Walton, president of Cambridge Associates (see last graph, below left).

Moreover, the top-performing quartile of endowments had, in the same time frame, an average private investment allocation of 24.1%, while the bottom quartile only had a 6% allocation.

The three best performing asset classes in the year to June 30, 2015 were venture capital, private equity and distressed securities, with annualised returns of 12.6%, 11.4% and 10.4%, respectively. They each outperformed the equity and bond markets on an equivalent basis, according to Cambridge. 

Falling barriers to private investment

And it is not only a handful of very large universities and foundations that have a high proportion of their assets in private investments, as is commonly believed.

It is true that the median asset size of the group with more than 15% in privates was $1.2 billion as of June 30, compared with a median of $105 million for the group with less than 5% in privates.

Yet for the same period, 174 institutions – almost 40% of the report’s universe – were in the top-performing group. Of that 174, 48 have assets below $500 million, including 26 below $250 million.

Another concern about private-market assets is their relative illiquidity. While institutions need to be certain that they have sufficient portfolio liquidity for all likely cashflow needs, the report noted that many entities place a value on liquidity that exceeds actual cash needs, even in worst-case scenarios. 

“Many institutions may find that a higher private investment allocation is well within their tolerance for illiquidity,” Walton said.