The Bid - The Evolution of Private Markets in Modern Portfolios
Episode Description:
When investors consider how to diversify their investment portfolios, traditional assets like stocks and bonds are often the first things that come to mind. But private markets have become increasingly prominent in the financial landscape. These unique investments can offer diversification benefits that are often insulated from broader economic cycles. So, what's driving this shift towards private market investments and how are these trends reshaping the strategies of investors compared to previous cycles? Paul Braude and Vidy Vairavamurthy, Portfolio managers at BlackRock, join Oscar to help us understand the current themes driving private market opportunities, how they identify and evaluate emerging trends, and how private market investments can complement public market exposures.
Sources: As companies stay private longer advisors need access to private markets, Nasdaq, August 2022; BlackRock with data from Prequin as of April 2024; Expanded DPO View
Written disclosures in each podcast platform and each episode description:
This content is for informational purposes only and is not an offer or a solicitation. Reliance upon information in this material is at the sole discretion of the listener.
Reference to the names of each company mentioned in this communication is merely for explaining the investment strategy and should not be construed as investment advice or investment recommendation of those companies.
For full disclosures go to Blackrock.com/corporate/compliance/bid-disclosures
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<<TRANSCRIPT>>
Oscar Pulido: When investors consider how to diversify their investment portfolios, traditional assets like stocks and bonds are often the first things that come to mind. But private markets have become increasingly prominent in the financial landscape. These unique investments can offer diversification benefits that are often insulated from broader economic cycles. So, what's driving this shift towards private market investments and how are these trends reshaping the strategies of investors compared to previous cycles?
Welcome to the bid where we break down what's happening in the markets and explore the forces changing the economy and finance. I'm Oscar Pulido.
Joining me are Paul Braude and Vidy Vairavamurthy. Portfolio managers at BlackRock, they'll help us understand the current themes driving private market opportunities, how they identify and evaluate emerging trends, and how private market investments can complement public market exposures. We'll also discuss the complexities and challenges associated with investing in emerging private assets and key takeaways for investors looking to capitalize on these trends.
Viddy and Paul, thank you so much for joining us on the bid.
Vidy Vairavamurthy: Great to be here, Oscar, we're really excited about the opportunity.
Paul Braude: Thanks for having us.
Oscar Pulido: So, we're going to talk about this term, private markets. I've also heard the term alternatives. Vidy maybe, first question to you, which is: alternatives, private markets, are these the same things? And how do they compare to the public markets?
Vidy Vairavamurthy: Great question. Oscar, I think in the context of private markets and alternatives, there's been an evolution, and I think the names themselves have gone through an evolution. I think if you go back 30 years, when you thought about classically where people are investing, it was largely in public markets.
So anything outside of that was viewed as alternatives that first came with hedge funds, and now we know the broad adoption around hedge funds globally in client portfolios and private markets are also going through that moment where historically it was really around a couple of different asset classes that people were collecting and now they're becoming much more mainstream and actually very much a part of all portfolios.
I think from a broad sense we would also acknowledge that public and private markets are effectively converging. Historically there's been a different perception around private markets. Private markets are often viewed to be much more risky. And why is it? Because a lot of the assets that were part of the private markets were riskier. For example, venture equity, as part of the private equity landscape. But that's changed. Now, both today, public and private markets offer a range of risk opportunities that we view as a spectrum, right? So, on the very low-risk side, high quality assets such as AAA corporate bonds to investment grade, infra debt on the private market side you can also lean into part of the areas that are much more risky. For example, you can invest in public tech stocks that exhibit a lot more risk than, say your traditional, value company, and also invest in growth equity companies in the latest AI company. Now we think that's how private markets are evolving and being a bigger part of the conversation when you think about the whole portfolio.
Oscar Pulido: Vidy, and we should have said public markets, maybe it sounds obvious, but we're talking about traditional stocks and bonds, these are companies that have IPO'd or in the bond space. This could be things like corporate bonds or government bonds, that's what you said are the traditional asset classes. And everything outside of that was thought of as alternative, and you started talking about private markets, things like private equity venture, infrastructure. That gives us a little bit of definition.
Paul, what else has been evolving in this space of private markets to get us to where we are today and where are we seeing some of the investment opportunities?
Paul Braude: Absolutely. So maybe I'll start at the same point in time that Vidy just referenced, or about 30 years ago. At that time, the private market universe was really looking very different in that you saw private equity, you had venture capital, and you had real estate segments. And importantly, access to those investments was really limited to institutional investors only.
Over time, we've observed remarkable growth in a private market universe as a whole. It now stands at over $13 trillion and is actually expected to grow much more to over 20 trillion by 2030. Importantly, private markets have grown not only in size, but in breadth as well. So, in addition to private equity and real estate infrastructure and private credit have now emerged as full-fledged asset classes.
On the one hand, the growth in these new asset classes has been driven by demand for private capital in the markets. So, for private credit, we see more demand for companies as they stay private for longer, and as their CFOs develop an appreciation for the flexibility and certainty of execution that private lenders can provide.
But for infrastructure, its growth has been fueled not only by the demand for traditional infrastructure investment. But also, by the build out needed to sustain the growth of, ai, of course, whether that's building new data centers to house all the computational power needed for it, or frankly, financing the development of the energy infrastructure required to provide the electricity and power to power all of these servers.
So, on the other hand, new and innovative structures have been developed over time to enable access to these private markets for more investors. And access is no longer limited to just large institutions. Individuals can now invest in these assets as well, through structures, called semi-liquid structures.
And I will say it's a rapidly evolving space driven by, regulation evolution globally, and I would expect there to be more evolution in terms of products and ways to access these private investments in responsible ways going forward. As private markets have grown more complex, we've seen an interesting evolution in opportunities that do not neatly fit the core private market strategies.
These are opportunities in niche or smaller assets, which effectively play the role of alternatives in alternatives. These investments can vary widely from taking on insurance related exposures to pursuing acquisitions of music royalties. But one common theme that unites them is that they tend to be less correlated to both traditional public markets as well as the larger core private market strategies. And as a result, these investments can provide benefits of diversification and resilience in investors' portfolios.
Oscar Pulido: Paul, you touched on the size of private markets going from $13 trillion now to, expected to be a $20 trillion in just the next couple of years. And then you also talked about what appears to be the democratization of access to some of these markets that maybe historically were hard to access. So, Vidy, when it comes to then a portfolio allocation, what role should private markets play in a portfolio and what might be some of the challenges that are involved with that as well?
Vidy Vairavamurthy: I'm going to build on some of the themes that Paul highlighted and give you what I think are three main reasons why investors would look to private markets.
I think first and foremost is an acknowledgement of the return potential that's available in private markets. You can be very disciplined in sourcing different risk within the private markets that can deliver differentiated forms of return, which could be hugely advantaged in your portfolio. And then the other component related to that is private markets is really where active management can deliver really enhanced performance because these are assets where there's a hands-on approach to actively managing the types of assets, value creation, and effectively monetizing those assets at much higher valuations than what you would typically see in some of the public market discussions had today.
The second is portfolio diversification. The ability to introduce real breadth into your portfolio and having different risks actually deliver that real diversification benefit and think about places where, for example, when you think about music royalties or other sort of different IP, those are risks that you're not being able to source today in public markets, which can provide a real ballast when you think about introducing, diversifiers to your portfolio, and you think about it today, the cash flows on what a record is doing in your music catalog has nothing to do with what's happening in the public markets,
And the last thing that's really exciting about private markets, as an investor that wants to be really targeted in the types of themes that they want to see in their portfolio, you can be very prescriptive in being able to say, ‘Hey, I want to play in digitalization or in decarbonization, or for example, demographic shifts.’ Those types of assets are very abundant in private markets and can provide that specificity that you want in that whole portfolio approach.
Now, with that comes the challenges that you acknowledge. I think the first and foremost, is the liquidity challenge, right? These aren't assets that you're going to be able to trade. Once you've made a decision with them, you're going to hold them in many cases for years. There is that challenge around how do you make decisions around private markets where you are trying to invest over multiple years? And the complexity today really comes from data. The data today has been, a slow going, but we're seeing an improvement in that. So, decisions around how do you think about value? How do you think about risk? How do you think about the different forms of liquidity that you need to solve for? I think there is that element of how do you do that with the right level of conviction that you would do in public markets.
And then the last thing that I would acknowledge is the convergence between public and private. not only are you seeing convergence in how we think about opportunities, but we're also talking about risks. So now more than ever, it's really important to think about how does the macro and the geopolitical considerations of our time affect how we think about trends that are going to play out over multiple years? And that is becoming really hard to do, and it requires a lot of expertise to do that
Oscar Pulido: As you're talking about the breadth in a portfolio, I think about a lot of the conversations we've had with investors on the podcast about this is a new market regime, the need to be more granular, the need to, look for sources of return in different places than maybe we did in prior market regimes.
Vidy, you started talking a little bit about the, some of the considerations that investors need to think about when making that differentiation between public markets and private markets, one of which is the time horizon. If you invest in public markets, you can get in and out pretty quickly, but you can't do the same in a private markets investment. What else is there that investors need to consider?
Vidy Vairavamurthy: One of the most important things that you need to think about is what are the sort of right risks that you want to include in your portfolio? I think one of the things that we observed is, classically it's really been, and when think about investing in private markets, it's really been an exercise around collecting.
What I mean to say is there'd be x, y, z manager out with a certain fund, and investors would evaluate that fund on a standalone basis. They would think about proven manager with a track record. I like the strategy, I'll invest. And they'll do that sort of iteratively through the opportunity set. And there was never really a unifying theme around how you made those decisions.
While then it made sense because those allocations were probably smaller. As those allocations are growing and we see institutional, investors in many cases having exposures of 30, 40 and sometimes 60% depending on their risk preferences, we're seeing that dynamic now evolve where more and more investors are thinking about how do be targeted around that exposure, and how do I think about this holistically?
Now, the approach that we think that's really critical to this is this total portfolio approach. Don't differentiate between your public and private. Think about, at a whole portfolio level, where do you want to be levered? What types of risks do you want to see? How do you think about the value that's being priced in markets today, both across public and private?
And then think about what are the forms of liquidity that you want to manage across? If you're a long-term investor, you can leverage that ability to think long-term and evaluate opportunities across that spectrum that we refer to on a risk basis, but also on a liquidity basis.
The other thing I want to highlight is the fact that you want to be flexible. You want to acknowledge the fact that there's a lot of things that you don't know in the market that will evolve through time. So having the ability and the discipline to think about what are the areas that you want to be tactical, what are the areas you want to retain some level of capital that if a change does manifest itself, you can take advantage of it.
Oscar Pulido: And an underlying theme that you're mentioning, Vidy, is that this is now a growing part of investor portfolio. So, the considerations that they have to account for are more and perhaps just more information that needs to be taken into account when thinking about how to allocate.
Paul, you said something about the alternative to alternatives and Vidy said something about music royalties as well. So, I think this is a space that is starting to emerge, I think we actually call it emerging private assets. I want to distinguish that from emerging markets, which is another topic we often cover. But talk to us more about these emerging private assets. How do they fit into the broader landscape of private markets? And can you give us some additional examples maybe?
Paul Braude: So maybe to set the stage, so private market strategies, they continue to expand in size and scope, and more and more sectors are benefiting from the flexibility of private capital as well as the financial innovation that they can provide.
But at the same time as private allocations become more prominent in investor portfolios, investors have been starting to look for diversification of those portfolios, and that is exactly where niche or emerging private assets can come in. So, these areas of private markets, which we believe represent an over $700 billion opportunity currently have been growing at a 15% annual pace over the last 15 years, which by the way, is actually faster than the overall growth rate for private markets as a whole. And because the segments usually start out at a much smaller scale, they tend to fly under the radar of traditional, larger scale private market strategies, which we believe can actually create some interesting and attractive investment opportunities.
So, one example since we've been talking about music, music royalties represent a very interesting, example of an evolution of a niche asset class. And by the way, music royalties, means buying the rights to intellectual property, that artists and writers can create, which then is associated with cash flows that the intellectual property generates, as we all consume content and listen to songs, for example.
So, 15 years ago that industry was basically non-existent, and any transactions were one off at best. And now, what we've seen is a growing demand from investors as they've seen data historically that shows that music consumption is really not correlated to what's going on in the market. And in fact, that was proven during the global financial crisis. At the same time, artists got more comfortable with selling their rights to these assets, and that has resulted in the growth in that industry, which is now estimated to be over $60 billion in size. So maybe a little bit less niche or emerging than it once was.
One other, maybe a little bit more esoteric example that I'll give is whiskey aging. So, the global demand for that spirit continues to increase, and the relatively long aging process has created an interesting point for patient institutional private capital to enter that space. And importantly, as whiskey ages in casks or barrels, its value actually increase is increasing. And so effectively you own an asset that is appreciating in value over time. And in general, for these types of assets, we focus on gaining access to businesses or cash flows that, increase in value and generate cash flows, regardless or frankly sometimes in spite of what might be going in on in the broader market. And it's exactly these types of qualities that create an attractive way to diversify or add resilience to investors' portfolios.
Oscar Pulido: It sounds like you can get very creative as to the assets that, make it into your portfolio and also just listening to the both of you. Is it right to say that when we talk about private markets, I think the core portions of private markets are things you've mentioned, like private equity, infrastructure, private credit.
These areas like music, royalties and whiskey are really those, and perhaps why you refer to them as the alternative to alternatives. These are really more niche, esoteric, growing, but still a smaller part of the private markets landscape. Is that how you would think about it, Paul?
Paul Braude: No, that's exactly right. And that's why we think they can be actually more attractive for certain investors as a way to access a differentiated set of exposures or differentiated set of investments than what they would otherwise be getting in the markets.
Oscar Pulido: Both of you as you scan the private markets, these are areas of deep expertise, for you both. what are some of the trends driving the growth of private markets that you're looking at the moment and take us forward, what are you seeing as we go forward into the future?
Vidy Vairavamurthy: Yeah. I think the first and foremost is, I think we should acknowledge on the supply side there's a significant evolution that's happening. What I mean to say is, if you think about how people invested in private markets 30 years ago, it was largely through closed end vehicles that were lockup vehicles that oftentimes were 10, 15 years as far as the length of time the capital was locked up.
The investment community itself is thinking about how do they adopt them appropriately into their whole portfolio. For example, as Paul highlighted, one of the areas, there's a lot of, innovation that's happening is in these products known as semi-liquid evergreen products. And these are products that are well suited for new investors, specifically in the wealth and retail space that want to have exposure to private markets, but adhere to some of their policy requirements, whether it be some form of liquidity, some form of transparency that's much more consistent to what they invest in their portfolios.
Other areas in the market, we can talk about the emerging spaces that Paul talk about, these alternatives, if you will. Those are really critical, right? When you think about some of the spaces that were less trafficked from an institutional capital perspective, as they become more exciting and more investible, that creates better, ways of creating opportunities in client portfolios to deliver alpha that you might not have been able to do 10, 15, 20 years ago.
Paul Braude: I'll add to that, that from a thematic perspective, we think that similar secular trends that are driving public markets are also applicable to the private markets. And of course, the proliferation of AI is one of those trends. And in addition to the computational power and energy that's needed to sustain the growth in ai, we've been focused on understanding how it will transform the various industries. I mentioned music royalties before, but the rise in that sector, I believe is more emblematic of a broader shift that we've been seeing in the way that we all consume content. So, the technology evolution that we've seen in particularly in streaming, has enabled all of us to access content so much more easily and with a lot less friction than we used to. And at the same time, for content creators, the creatives, they can create content much more cheaply and make it much more accessible to the rest of us. In addition, we've seen a lot of crossover in the way that intellectual property is monetized. So what I mean by that is think about video game, intellectual property, and all the TV shows that have now come out based on video games. Or think about all the, beloved artists and singers that we know who have now become movie stars, right? And we believe there's a con continued opportunity in this entertainment IP space ranging from music to tv, to live theater, and of course to sports. And sports in particular has been a red-hot area for private investors.
But I will say that we're quite conscious of the changing environment more broadly and what this higher inflation and higher interest rate environment is going to bring us and how the geopolitical risk, is going to affect the investment landscape.
Oscar Pulido: Paul, you're making me, think as I walk around on the street, I'm going to be looking to see can I monetize that particular asset because you're certainly, making me realize that there are a lot of distinct ways to bring return streams into your, portfolios. Vidy and Paul, thanks for sharing all this expertise, on the private markets, giving us a little bit of a history lesson, but also taking us forward a bit. And thank you for doing it here on The Bid.
Paul Braude: Thanks a lot. Thanks for having us.
Vidy Vairavamurthy: Thank you, Oscar. It's been great.
Oscar Pulido: Thanks for listening to this episode of the Bid. Next up, we dive into the exciting world of growth and venture debt. Exploring the dynamic shift towards debt financing and what it means for the future of investments. If you want to keep up with what's happening in the economy and the latest market trends, make sure to subscribe to the bid wherever you get your podcasts.
<<THEME MUSIC>>
Spoken disclosures at end of each episode:
This content is for informational purposes only and is not an offer or a solicitation. Reliance upon information in this material is at the sole discretion of the listener.
For full disclosures go to Blackrock.com/corporate/compliance/bid-disclosures
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