Institutional Investors Turning to Private Funds for Returns

Cerulli Associate’s second quarter 2017 issue of The Cerulli Edge, U.S. Institutional Edition, finds expectations for low returns across traditional asset classes are leading large-scale asset owners to invest more in private equity, with the aim of boosting returns and diversification.

“The persistent low-return environment has led several institutions to cut their assumed rates of return,” says Michele Giuditta, associate director at Cerulli. For example, the two largest U.S. public pensions, The California Public Employees’ Retirement System and the California State Teachers’ Retirement System, plan to gradually lower their target rates to 7% from 7.5% during the next couple of years, according to Cerulli’s survey data.

Giuditta observes that future return expectations for a traditional 60/40 equity/bond portfolio are “only in the low to mid-single digits,” below return targets of most institutional investors, especially pension plans. “Accordingly, many are turning to more illiquid private investments—private equity, private debt, private real estate, infrastructure, and natural resources—to meet their long-term return goals.”

Cerulli further reports an increase in institutional investor use of “private closed-end funds,” to meet multiple objectives in their portfolio.

“The wide range of private fund strategies can generate strong returns, provide diversification, reduce volatility, act as an inflation hedge, and/or deliver reliable income,” Cerulli researchers explain. “The clear majority of general partners surveyed by Cerulli identify diversification (89%) and enhanced returns and asset growth (79%) as the primary objectives of their private investment funds.”

Cerulli concludes it is encouraging to see institutions are “exploring a wider range of investment structures … As more investors seek a greater level of control and customization of their private investments, separately managed accounts and co-investments are becoming more prevalent.”

Information about obtaining Cerulli Associates research reports is available here.