CREATE-Research has a new study which shows show investors are becoming far more discerning about investing in private markets and emerging markets, as central banks have withdrawn liquidity and geopolitical risks have begun to dominate the thinking of pension investors worldwide.
Executive Summary
Introduction and aims
“The global economy is being splintered by worsening relations between America and China. Relying on the typical cyclical playbook may be unwise.” An interview quote
As pension investors transition to a new regime, one question has come to the fore: where will the returns come from?
The Great Moderation of the past 25 years was marked by stable economic growth, low interest rates and low inflation. They favoured ‘set-and-forget’ asset allocation. That was shattered by four recent cascading game changers: the severe monetary tightening by key central banks to tackle the inflation spike; worsening conflicts in the Middle East and Ukraine; the rise of populism in the West due to the cost-of-living crisis; and the US–China geopolitical rivalry fragmenting the intricate web of global supply chains. That integration is now seen as a source of risk and insecurity.
On the upside, however, this is also creating opportunities as capital markets adjust to the new regime. With public equity markets in the West flirting with their all-time highs, the search for good risk-adjusted returns is turning the spotlight on two sets of thus far underinvested asset classes.
The first set covers illiquid assets in private markets, benefiting from the recent surge of investment in strategic sectors like AI, defence, renewable energy and infrastructure. Private markets are increasingly seen as providing exposure to innovation while IPO activity remains sluggish, especially in Europe. As such, they are viewed as a most likely source of value creation for the foreseeable future.
The other set covers Asian emerging market assets in the world’s fastest growing region. It accounts for 46% of global GDP, 60% of the world’s population and 60% of expected global growth through 2030, according to the IMF and the World Bank. The centre of gravity of the world economy is shifting towards this region, according to current narratives. Hungry for foreign capital to facilitate energy transition, they are also implementing investor-friendly reforms.
Hence, the 2024 Amundi–CREATE global pension survey has a twin focus on asset classes in private markets and Asian emerging markets. On a three-year forward view, it addresses five questions:
- what are pension plans’ current allocations to these asset classes and how are they likely to change?
- which factors have constrained allocations so far and which ones will likely drive them in future?
- what specific investment benefits are being targeted and to what extent have expectations been met?
- how is the mix of components within each of the broad asset classes likely to change?
- which selection criteria will be used when awarding new mandates to external asset managers?
The survey involved 157 pension plans in 13 key jurisdictions, collectively managing €1.97tn of assets (see figures below). The survey results were bolstered by 30 structured interviews with senior decision makers from respondent organisations. The survey provided the breadth, with interviews adding depth and insight. The rest of this section presents the survey’s highlights and key findings in two parts.
Survey highlights
(% of pension plan respondents)
Part 1: Private markets
Private markets face improved prospects due to the current rate-cutting cycle
Currently, 74% of survey respondents have already allocated sums of varying proportions to private markets in total: 49% have allocations of up to 15% and the remaining 25% have above 15% (Figure 1.1). These investments are part of their strategic asset allocation (SAA).
The size of a respondent’s portfolio allocation has varied directly with the size of their respective asset base. Those with a larger base have had the requisite governance structures, skill sets and time horizons to venture into illiquid assets.
The biggest allocations originate from the US, followed by Europe and Asia-Pacific. The US is also the favourite destination of these allocations, making it the epicentre of private markets. Europe is the next favourite centre.
Thus far, the allocations have been constrained by many factors (see Section 2). Of these, the two key ones are external to private markets. One is rising geopolitical risks, which are hard to model and difficult to price. Another is the steep spikes in the benchmark US Federal funds rate from zero bound in 2020 to its 23-year high in 2023 that sparked a major reversal in asset values.
For private equity, that hit the IPO pipeline in volatile markets, making exits difficult for maturing funds. In private debt, higher rates jacked up the default rates and forced loan restructuring. In infrastructure and real estate, they raised funding costs and hit capital values.
Before then, there have also been other factors inherent to private market assets that had constrained allocations. High fees and charges top the list. This applies to the traditional 2-20 fee model in private equity, venture capital and, to a lesser extent, private debt. It reflects the fact that private assets need customised contracts that are harder to replicate and rely solely on active management, unlike their public market peers.
Other inherent constraints include opacity in the investment process and performance evaluation; high friction costs caused by premature exit; high dispersion in ultimate investment returns; and an all-time high level of ‘dry powder’ – sums allocated but not invested, waiting for opportunities to arise.
On balance, the current levels of allocations owe less to these inherent constraints and more to steep and prolonged rate hikes in the recent past.
However, on a three-year forward view, our respondents expect the outlook to improve for private markets. The proportion of respondents investing in them is likely to rise from 74% to 86%, with rising shares in the asset base (Figure 1.1). For them, the price of going into private markets is only exceeded by the cost of staying out. Two sets of drivers are now in play (see Section 3).
On the external side, the search for good risk-adjusted returns tops the list of our respondents. With public equities flirting with their all-time highs, private markets are seen as a more credible option. Another key driver will be continuing cuts in interest rates started in 2024 by the main developed market central banks and most of the emerging market central banks, including China. Survey respondents expect the Fed funds rate to fall to 3.75% over the next two years. Fresh tailwinds will be reinforced by two further drivers: the ongoing de-equitisation that is shrinking the universe of public markets; and European regulators relaxing the liquidity rules and price caps in defined contributions pension plans.
These external drivers are expected to be bolstered by three drivers that are inherent to private markets. First, ever-more growth companies are coming to private markets and remaining private for longer. Second, fund covenants are offering more effective opportunities for engagement on environmental, social and governance issues (ESG). Third, secondary markets are evolving to offer liquidity in periods of financial stress.
Interview quotes
“A growing share of global value creation takes place in private markets, and companies are also remaining private for longer.”
“We are cautiously optimistic that things will be trending in a better direction once cuts in interest rates progress over the next 2-3 years.”
Pension investors are becoming more demanding as the market environment has changed
To read and download the full report, click here.
About CREATE-Research
CREATE-Research is an independent research boutique specialising in strategic change in global investment management. Its main focus is innovations in the newly emerging: asset allocation models, business models, client service models, product development models, and digital infrastructure.
We undertake major research assignments from prominent financial institutions and global companies. We work closely with senior decision makers in reputable organisations across Europe and the United States.
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