Private Assets vs. Public Markets: Understanding the Distinct Performance Dynamics
In 1985 David Swenson took over management of the Yale University Endowment where he pioneered an investment approach that would come to be known as "The Yale Model" and eventually be emulated by pensions, sovereign wealth funds, endowments and the ultra-wealthy. In essence, Swenson's investment thesis was that the portion of the fund that wasn't required to be paid out in the near-term, should be invested to favour higher returns, even if that meant taking more risk. If there was no need for the entire fund to be immediately liquid, why not invest in assets that were likely to produce higher returns in the long-term. Swenson and his team began allocating a portion of the fund to private assets, hedge funds and venture capital. Eventually those "alternative" assets made up about half of the fund, with private assets accounting for the lion's share. The outcome? From 1985 to 2021, The Yale Endowment returned 13.7% per year vs. 8.8% for the S&P500 and 10.3% for the average endowment (Source, "The Evolution of the Yale Model for Institutional Investing", www.chronograph.pe).
Canadian pension funds were among the first to embrace the concepts of the Yale model and put them into widespread practice with significant assets. Since then, the fund has delivered exceptional total returns that have kept up with exceptional returns from public stocks, while maintaining a high level of diversification producing smoother returns and avoiding the substantial drawdowns that portfolios with higher concentrations in public stocks experienced every few years.
Canadian pension funds were among the first to embrace the concepts of the Yale model and put them into widespread practice with significant assets. Since then, the fund has delivered exceptional total returns that have kept up with exceptional returns from public stocks, while maintaining a high level of diversification producing smoother returns and avoiding the substantial drawdowns that portfolios with higher concentrations in public stocks experienced every few years.
The Canadian Pension Plan Investment Board (CPPIB) is amongst the largest pension funds in the world. They are also one of the staunchest supporters of the benefits of private assets. As is evident in their asset allocation in Figure #1 below, nearly half the portfolio is held in private assets (Infrastructure, Real Estate and Private Equity). To emphasize their commitment to private assets and the evolving opportunity set, they recently announced their intention to double their exposure to private credit, a sector that allocated to early this year.
CPPIB is arguably one of the best-managed multi-asset funds in the world. Nevertheless, the returns from other major, well-run pension funds (i.e. Ontario Teacher's Pension Plan, OMERS) have demonstrated similar outperformance attributable to private assets and a lower risk profile than traditional, public stock/bond-only portfolios, see Figure #2 (above).
Why and how do private assets perform differently than their publicly traded counterparts? According to Capital IQ, privately held companies with more than $250 million in revenue account for 86% of investable businesses. At the risk of over-simplifying, there are more opportunities. Recall, from 1971 to 1990, pensions and RRSPs were restricted to only 10% foreign content. That limit was gradually reduced and ultimately eliminated in 2005, thus allowing Canadians to seek additional investment opportunities in global markets. Expanding investment mandates to include private assets is akin to moving from a domestic-only portfolio to one that can invest globally.
Since 2010, the TM Wealth Management Group has strived to emulate the investment strategies of the world’s best institutional investors. There was (and still is) a vast difference in how pension funds and individual portfolios are managed. As of 2023, pensions held 23% in alternative assets, while individual investors held less than 3% (source, Blackstone, "Long-Term Investing in a Short-Term World", May 2024). Given the clear performance advantage many institutional investors have demonstrated, we are perplexed at the lack of adoption of their strategies by our peers in the private wealth management industry.
Diversified returns became increasingly important as interest rates plummeted and the valuations on traditional bonds and stocks became increasingly stretched. So, when a few trailblazing fund companies began offering private asset exposure to individual investors in the late 2010’s, we took notice. We knew private assets had been a cornerstone of many institutional portfolios for decades, however, we always take a cautious approach when new investment opportunities appear in our market. Several funds, especially ones managed by smaller Canadian companies, predominantly managed money for individual investors because they did not meet the tight standards of institutional investors. This was a red flag for us. We favour working with fund companies and strategies that had been selected and proven by institutional investors, of which there is now a robust universe to choose from.
The sea change for individual investors was the development of perpetual "evergreen" funds, with no fixed termination date. Traditional private asset funds structures have lifespans of about ten years. In the early years, investor's cash is "called" to fund asset purchases, then in the later years of the fund's life, assets are sold, and cash is returned to investors. Perpetual funds enable investors to make regular purchases and redemptions from a fully invested portfolio (much like a traditional mutual fund), a pre-requisite for most individual investors. The perpetual structure also helps further focus managers on long-term performance of the businesses/assets they own, rather than the "fix and flip" model that closed-end funds had been criticized for. Perpetual funds are spawning a cultural shift at private asset firms toward a "buy and build" model. We value this emphasis on long-term value creation, as it aligns the managers interests with our own.
The same fund managers that dominate the institutional private asset market are the same ones leading the development of perpetual funds for individual investors. These managers include Blackstone, KKR, Hamilton Lane, Brookfield Oaktree and Apollo. Importantly, these managers have strict rules to ensure their funds for individual investors can invest in the same deals as their institutional funds.
There are four sub-categories of private assets – equity, credit, infrastructure and real estate. Each of these carry their own unique opportunities and investment characteristics, thus allocating to a mix of these assets further diversifies portfolios. Most of the large private asset managers have specialized divisions that invest in all four categories. Investing across asset classes provides opportunities for economies of scale, for example, Blackstone has their own buying group, so the companies benefit from the most competitive prices from everything from shipping rates to sourcing raw materials. Scale also provides a huge volume of real-time data. Blackstone was able to identify inflation across their businesses and real estate (rents) well before central banks and thus were able to transition most of their borrowing to fixed-rate loans.
By the start of 2020, our portfolios had a material allocation to private assets. Although the quantity and quality of opportunities available in 2020 was a fraction of what it is today, our portfolio of private assets has delivered substantial benefits to portfolio returns over those four and half years. At times that performance benefit meant higher returns and at others it meant risk management – we believe that is true diversification. Stocks tend to provide solid long-term returns, but they are highly volatile and are prone to substantial drawdowns. Bonds looked increasingly unattractive as yields moved toward zero post-pandemic. Since 2020, the global bond market has produced a negative total return while stocks have only recently surpassed the returns of our private asset investments, that said, stocks took the long road to get there, with two drawdowns of approximately 20%.
None of this is to say we believe there is anything wrong with public stocks and bonds, quite the contrary. We believe the best path to solid returns while managing risk is a healthy balance of public and private assets. There are environments where public assets will do better and vice-versa. That said, historically private assets have outperformed their publicly traded counterparts consistently for decades. Regardless, we believe having more levers to pull to adapt to changing environments and opportunities is a substantial advantage for investors. A clear example was post-pandemic when bond yields approached zero and stocks traded at high valuations. As central banks raised rates, stocks and bonds fell in unison, making rebalancing of a traditional portfolio difficult if not pointless. Our private asset exposure provided diversified exposure and those funds were able to price-in higher interest rates more gradually than public stocks and bonds. As interest rates stabilized at higher levels, we were able to pivot back into public bonds.
There is no such thing as a free lunch. Everything involves trade-offs. Hence why we fully embrace owning a wide range of assets. The quality of those assets is critical to us, more so than how they are labeled. Across all our investment decision-making, one of the primary metrics we consider is that we need to "get what we pay for". If we are going to give something up, we need to be confident we are receiving additional value in return. Private assets meet that threshold, but not all private asset funds are created equal, so we conduct significant due diligence to identify the best opportunities within the asset class.
As stocks hit all-time highs, (from an increasingly concentrated group of companies), investors need to ensure their portfolios are well diversified, and yet, few want to be side-lined while markets run higher. Although bond yields are attractive relative to recent history, they are now highly correlated with stocks at nearly 80% (meaning prices move mostly in the same direction at the same time), implying they are not providing as much diversification as in the past. We believe private assets provide us and our clients the opportunity to maintain long-term return objectives while not rolling the dice being concentrated in the few mega-cap stocks that are driving current returns.
The evolution of perpetual private asset funds has expanded our opportunity set immensely and we are excited by the potential for portfolios going forward. The TM Wealth Management Group is one of few select groups in the Canadian wealth management industry that has years of experience and expertise investing in private assets and has made it a cornerstone of our portfolio strategy. We believe this is a transformative opportunity for individual investors and are thrilled to be at the forefront of this trend on behalf of our clients.
Since 2010, the TM Wealth Management Group has strived to emulate the investment strategies of the world’s best institutional investors. There was (and still is) a vast difference in how pension funds and individual portfolios are managed. As of 2023, pensions held 23% in alternative assets, while individual investors held less than 3% (source, Blackstone, "Long-Term Investing in a Short-Term World", May 2024). Given the clear performance advantage many institutional investors have demonstrated, we are perplexed at the lack of adoption of their strategies by our peers in the private wealth management industry.
Diversified returns became increasingly important as interest rates plummeted and the valuations on traditional bonds and stocks became increasingly stretched. So, when a few trailblazing fund companies began offering private asset exposure to individual investors in the late 2010’s, we took notice. We knew private assets had been a cornerstone of many institutional portfolios for decades, however, we always take a cautious approach when new investment opportunities appear in our market. Several funds, especially ones managed by smaller Canadian companies, predominantly managed money for individual investors because they did not meet the tight standards of institutional investors. This was a red flag for us. We favour working with fund companies and strategies that had been selected and proven by institutional investors, of which there is now a robust universe to choose from.
The sea change for individual investors was the development of perpetual "evergreen" funds, with no fixed termination date. Traditional private asset funds structures have lifespans of about ten years. In the early years, investor's cash is "called" to fund asset purchases, then in the later years of the fund's life, assets are sold, and cash is returned to investors. Perpetual funds enable investors to make regular purchases and redemptions from a fully invested portfolio (much like a traditional mutual fund), a pre-requisite for most individual investors. The perpetual structure also helps further focus managers on long-term performance of the businesses/assets they own, rather than the "fix and flip" model that closed-end funds had been criticized for. Perpetual funds are spawning a cultural shift at private asset firms toward a "buy and build" model. We value this emphasis on long-term value creation, as it aligns the managers interests with our own.
The same fund managers that dominate the institutional private asset market are the same ones leading the development of perpetual funds for individual investors. These managers include Blackstone, KKR, Hamilton Lane, Brookfield Oaktree and Apollo. Importantly, these managers have strict rules to ensure their funds for individual investors can invest in the same deals as their institutional funds.
There are four sub-categories of private assets – equity, credit, infrastructure and real estate. Each of these carry their own unique opportunities and investment characteristics, thus allocating to a mix of these assets further diversifies portfolios. Most of the large private asset managers have specialized divisions that invest in all four categories. Investing across asset classes provides opportunities for economies of scale, for example, Blackstone has their own buying group, so the companies benefit from the most competitive prices from everything from shipping rates to sourcing raw materials. Scale also provides a huge volume of real-time data. Blackstone was able to identify inflation across their businesses and real estate (rents) well before central banks and thus were able to transition most of their borrowing to fixed-rate loans.
By the start of 2020, our portfolios had a material allocation to private assets. Although the quantity and quality of opportunities available in 2020 was a fraction of what it is today, our portfolio of private assets has delivered substantial benefits to portfolio returns over those four and half years. At times that performance benefit meant higher returns and at others it meant risk management – we believe that is true diversification. Stocks tend to provide solid long-term returns, but they are highly volatile and are prone to substantial drawdowns. Bonds looked increasingly unattractive as yields moved toward zero post-pandemic. Since 2020, the global bond market has produced a negative total return while stocks have only recently surpassed the returns of our private asset investments, that said, stocks took the long road to get there, with two drawdowns of approximately 20%.
None of this is to say we believe there is anything wrong with public stocks and bonds, quite the contrary. We believe the best path to solid returns while managing risk is a healthy balance of public and private assets. There are environments where public assets will do better and vice-versa. That said, historically private assets have outperformed their publicly traded counterparts consistently for decades. Regardless, we believe having more levers to pull to adapt to changing environments and opportunities is a substantial advantage for investors. A clear example was post-pandemic when bond yields approached zero and stocks traded at high valuations. As central banks raised rates, stocks and bonds fell in unison, making rebalancing of a traditional portfolio difficult if not pointless. Our private asset exposure provided diversified exposure and those funds were able to price-in higher interest rates more gradually than public stocks and bonds. As interest rates stabilized at higher levels, we were able to pivot back into public bonds.
There is no such thing as a free lunch. Everything involves trade-offs. Hence why we fully embrace owning a wide range of assets. The quality of those assets is critical to us, more so than how they are labeled. Across all our investment decision-making, one of the primary metrics we consider is that we need to "get what we pay for". If we are going to give something up, we need to be confident we are receiving additional value in return. Private assets meet that threshold, but not all private asset funds are created equal, so we conduct significant due diligence to identify the best opportunities within the asset class.
As stocks hit all-time highs, (from an increasingly concentrated group of companies), investors need to ensure their portfolios are well diversified, and yet, few want to be side-lined while markets run higher. Although bond yields are attractive relative to recent history, they are now highly correlated with stocks at nearly 80% (meaning prices move mostly in the same direction at the same time), implying they are not providing as much diversification as in the past. We believe private assets provide us and our clients the opportunity to maintain long-term return objectives while not rolling the dice being concentrated in the few mega-cap stocks that are driving current returns.
The evolution of perpetual private asset funds has expanded our opportunity set immensely and we are excited by the potential for portfolios going forward. The TM Wealth Management Group is one of few select groups in the Canadian wealth management industry that has years of experience and expertise investing in private assets and has made it a cornerstone of our portfolio strategy. We believe this is a transformative opportunity for individual investors and are thrilled to be at the forefront of this trend on behalf of our clients.
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