255: The Rise of Private Markets: Access, Liquidity, and Portfolio Diversification

[Music] Once the domain of large, sophisticated, and primarily institutional investors, private markets are now making their way into individual investor portfolios in a much bigger way. As companies stay private longer and seek new ways to diversify their borrowing needs, investors are asking a big question. Is it time to expand the investment universe to include both public and private markets? 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 Palito. We're coming to you live from the future proof citywide conference in Miami, where investors, advisors, and asset managers are gathering to talk about what's next. And one topic that keeps coming up, is private markets. I'm joined by John DeOrio, head of product and alternatives for BlackRock's U.S. wealth business. We'll discuss how access to private markets has expanded dramatically over the last decade, and what new considerations come with that access, from liquidity and time horizon to complexity and risk. John, thank you so much for joining us on the bid. Great to be here, Oscar. Thanks for having me. And John, we are at the future proof citywide conference in Miami. This is an event that brings together investment professionals from the asset management industry, as well as the wealth management industry. The conference is really here to talk about trends over the next year. One of those trends that is being talked about here at the conference, and that has actually been in the headlines over the last few years, are alternatives and private markets. This is a space that you know well. And these are categories that investors are increasingly more interested in. So maybe talk a little bit about alternatives and private markets. Are these the same things? And why are people interested in investing in these now? It's great to be here in Miami. For those of you that can't see, we're actually out on the beach here. It's a very interesting conference, very dynamic, and so we're getting some great engagement. Oscar, especially to what you're talking about around alternatives in private markets. And I think the first thing that we hear a lot is how do I start to think about alternatives? And I think there's a reason for that. If you think about the traditional 60/40 portfolio, we're recording this in March. You know, that's traditional 60/40 portfolio as of February 28th. It's up over 14% over the last three years. And so I think there's two dynamics there. One, which is maybe clients feel like they haven't needed other forms of diversification. But I think what's happening now is volatility is picking up. You're moving into another year of what has been an equity bull market. People may be a little bit more concerned around the role that fixed income can play in the portfolio. It's ballast. One of the things that we've been talking about is you need to have more durable portfolios. You need diversification in there. I think that is really where alternatives in private markets can take advantage of that dispersion. It can give clients a smoother ride so they can stay invested. I think that's the number one reason that we see clients using alternatives. Is they pivot a little bit to private markets, specifically as a subset of alternatives. The markets have just evolved so much. The example I like to use goes back over 50 years. And 50 years ago, the Willshire 5,000 index came out in 1974. And as you could imagine when it came out, it had 5,000 stocks. That index got up all the way up to over 7,500 stocks right before the tech bubble in the late 90s. Today it's sitting at around 3,400 stocks. So the number of publicly traded companies since the late 90s has cut in half. I think the other thing that we're seeing is if you want to have access to that entire opportunity set, you really need to think about private markets. Whether it's on the equity side, a lot of financing is now done in the private credit markets. Real estate, a lot of transactions are not done publicly. So private real estate. And certainly we see a generational opportunity and infrastructure. Much of that is also done in the private market. So there's some really big asset classes out there that if you want to get access to them, you really need to be in the private markets to get them. And you mentioned a couple things. You talked about the 60/40 portfolio, which has done well over the last couple of years. But recent market volatility is a reminder that it's always good to think about other diversifiers. And the BlackRock Investment Institute and their 20/26 outlook talked about this diversification mirage. That sometimes it's hard to find diversification. Therefore you have to look broader and maybe alternatives in private markets are part of the way to do that. You also talked about access. And private markets, I think historically, are a playground for more sophisticated or maybe more institutional investors. For the individual investor, it's been hard to access. But that's changed a lot over the last 10 years. So what's been the impetus for that change? Let's start off by why you'd want access. So I'll use that example of companies staying private longer. Let's use a company like Amazon that everybody knows. Amazon actually won public in 1997. Their market cap, when they won public, was about $400 million. Their market cap today is around $2.4 trillion. So all of that wealth creation and growth, that actually happened in the public markets. Now what you're seeing as companies are staying private longer, clients want access to that. There's a lot of really interesting companies, most of the economy, actually the private markets, are bigger than the public markets. So if you want access to higher yielding income or some of these interesting growth companies, you need to get access to through the private markets. And that's why we've seen institutions really investing in private markets for quite some time. I think the issue for wealth and the typical individual client was they couldn't actress that. And I think two things have really changed. One is structure, the other one is technology. And structure, there's been a lot of different interesting products that have come out that have not given the wealth community access to these investments. And then the second thing is technology. It used to be pretty hard to get invested. You used to have what's called QP qualifications. So that's higher suit abilities. Used to get K1s, which makes your tax documents a little bit harder. And so there's been a lot of technology and sort of legal interventions that have made it easier for clients to go ahead and invest. And I think that's been really important to get clients access as well. So you touched on the wheelchair 5,000 and how there's still a lot of investment opportunity in public markets. But maybe not as much as was the case over the last few decades. And so therefore there's an investment opportunity in private markets that investors are interested in. But the access has gotten easier. It's become more convenient. The vehicles exist to make the access to those opportunities easier. So does that mean that private markets, John, are for everyone or are there certain characteristics that people need to keep in mind? That therefore it's more selective who should invest in this? I think the answer is private markets are not for everyone. A financial advisor needs to sit down with a client and understand their long-term plan. But what we see is alternatives in general in private markets can play different roles. There's some alternative strategies that can provide you a hedge. Think about something like commodities, which you can get in the public markets, but some of them are more private in nature. We talked about those diversification benefits. Some clients might want to amplify their returns too. And as you go into the private markets, you can get amplification of return by being in the private equity, where you can get higher yields or higher returns than you may be able to get in the public markets. The answer first is what is the role that you want alternatives of private markets to play in your portfolio? I think that needs to be very intentional and you need to understand what that's doing for your portfolio. The second thing is what is your time horizon where you're putting these things? This is one of the reasons that I think private markets and retirement accounts has been a big topic. For example, that tends to be an interesting area, even though a lot of people aren't doing it. But those are typically longer-durated assets, right? Where people have long-term time horizons. They're going to be very strategic in nature. You're saving for something that's maybe 10, 20, 30 years away. Something like that is very interesting for private markets because there's no liquidity mismatch. We would say for somebody that's just looking to become tactical, you need to have a longer-term time horizon. These products were not created to be tactical products. They were really created for strategic allocations. And going back to our original point, which was to provide access that making sure they know what they're buying. And let's maybe talk a little bit more about that. You mentioned that one of the ideal places in a portfolio for private markets might be a retirement. Account where you have a long-term time horizon. And where presumably you're not touching that money that often, right? It's really meant to be there 20, 30 years and beyond for when you retire. So liquidity is very different in the private markets versus the public markets where you can transact every day. You have to be willing to sacrifice some liquidity when you invest in private markets. Talk a little bit more about how investors should think about that and think about the time horizon. They have to see when they put money to work there. So first I'll tell you how we think about it. And then I'll tell you how investors think about it. Private markets can sometimes be ubiquitous, broad category. But as we said, there's different segments to it. So for example, if you think about something like infrastructure, these tend to be longer-durated assets. They don't really fit that great right now into these evergreen-type vehicles because you have to buy large assets. You have to improve those assets typically and they tend to be longer-durated lines. If I think something like a private credit or something like that, these are shorter-duration assets that are turning over more. You have more visibility into those cash flows that are coming. And so it allows us to more easily manage that. Now that said, because it is private and to your point, there's a complexity premium, the liquidity premium. Most of these products, state up front that you're only going to have typically about 5% quarterly liquidity. And so I think it's really important that investors know that's a feature, right? Some people think about it sometimes as I can't get my money out or it's a bug, but it's really a feature because that allows the portfolio management team to go ahead and harvest that complexity premium, harvest that liquidity premium. And the most important thing I think around private markets is that sourcing, right? You have to go out and find those opportunities. I think a lot of times people compare private markets to public markets. They're vastly different. It's not like you can go out and buy something on exchange or that's publicly traded. You actually have to go and source those assets. And so there's just a different time horizon associated with that. And just when you say illiquidity premium, I think people understand the term illiquidity, meaning I can't get access to my money as quickly. But the premium means that historically private markets offer a premium return relative to public markets. So you are being compensated for what? You're being compensated for that. So when we go in, a company might not want to go to the public markets for various reasons. Sometimes some of those can go to the public markets. They choose to go to the private markets for regulatory purposes or speed or they have comfort in that market. But with that typically, so if you were taking the private credit example, typically over time you get about a 200 basis point premium over what you would get in those public markets. And 200 basis points and yield that can add up. So there's certainly a strategic reason to do it. But you have to understand that you are getting that illiquidity premium and that comes with the liquidity constraints that private markets have. Let's go back to the topic of access to private markets. If somebody's approaching this for the first time, maybe you can help define those topics again or let's go into a little bit more detail on what that means. Yeah. And so one of the questions I always got asked is a lot of people in the beginning of the conversation, not their head, yes. That all makes sense. The opportunity set in private markets are there. The performance has been there. I want to add it to the portfolio. And the question I always got asked asked is, so in wealth, though, allocation to alternatives in private markets still remains much lower than what we see in typical institutional clients. Actually, we just did a really interesting survey at BlackRock where we surveyed over 1,000 advisors. And what we saw actually now is actually for the first time over half of them are using private markets with individual investors and clients. But the allocation still remains low. It's actually about 7%. So it's moving up. But that's still below where we see a typical institutional client. So the question becomes, why is that? And I think the biggest issue is there's a lot going on. So doing the due diligence on this, understanding how to manage all of these can be quite difficult. And so I think that's where there's really an opportunity for the industry, which is right now many of these private markets are being bought on the side of a portfolio. And they might not fit in holistically to your plan. People are buying them because they think they're exciting or they buy into the thematic narrative that the product is talking about. But they're not fitting into that kind of portfolio construction. And you started off the conversation saying, you need to look at things like correlations. And how does this fit into the portfolio? And so we think one of the really interesting things is starting to think about how to get these into model portfolios and start managing these more professionally. That way, private credit can be an allocation that's part of your fixed income sleeve. Private equity can be an allocation that's part of your equity sleeve. It doesn't need to fit in a separate alt-spucket. It can be integrated into the portfolio. And then you understand exactly what role it's playing. And so I think there's still a lot of confusion and diligence that needs to be done in the space. Right. I think what you're saying is that the industry has sort of two responsibilities. Maybe part of it is educating investors. What are private markets? What are we talking about when we use that term? But also, how do you use them? How do you allocate them? What should you be replacing in your portfolio when you're allocating to the space? Yeah, the fit and function we call it, right? Where does it fall into a model portfolio, I think, is critically is critically important? Let's talk about some of the challenges. Presumably, there are some things that we have to consider as challenges when allocating to private market. I think a lot of the picture that you've painted is it's a great opportunity. More investors should be allocated here. But what's the other flip side to that coin that you see from the conversations that you have? I think the first challenge is what we touched on, which is there's a diligence challenge on this, which is private markets are inherently less transparent. Now, I think the industry through education around trying to provide data. So I think the industry is trying to make the private markets more transparent. So you can understand the risks that are inherent in the portfolio a little bit better, but they're inherently less transparent than public markets. And so therefore, challenge number one is understanding that can be difficult. Number two is if the advisor decides that they do want to change their allocation, it is easier to do in the public markets, right? Because public markets are daily liquid. And so the first challenge is you might be a little bit unsure around how this fits into the portfolio. You need some help. Number two might be you're worried about making a mistake, right? And so when you're worried about making a mistake and you don't have confidence, that is always a challenge. Third, you hit it right on the head, which was just education, which is clients really need to be educated on what role these plan the portfolio and how, again, they should be physically be fitting into the portfolio. And so that time-hur-ized conversation, that that portfolio conversation is really important. And so John, given everything we've talked about, I think you've done a great job of helping us understand what are our private markets? How is the space evolved? How is the access improved? And what are some of the challenges? So for somebody who's listening to this, what's that next step to think about starting to build that allocation to private markets in their portfolio? I think the next step is twofold. The first example I like to give is on the complexity side of it. The example I've given is it reminds me of the early days of getting around. When I was a kid, my dad had to pull out the map and going to a basketball tournament was difficult, because you didn't know exactly how to get there and you were checking. And then all of a sudden, map quests came along, and you could actually print out the instructions. And then you had the GPS device that went on, but it didn't quite work if you were in the Miami heat because it overheated. But now that's all integrated in, and it's seamless technology. I think that is where we are ultimately going with private markets, which is, the industry is really looking to integrate this in. And so I think number one is convenience around trying to really fit this in. I think the second is just providing asset allocation I pay and guidance as to where it fits. That's where the industry is going. I do remember printing out map quests directions. I'm digging myself there. Oh, I remember having them in the passenger seat on my way somewhere, but you're right. It has gotten a lot easier to navigate. And hopefully it'll get a lot easier to think about how to allocate to private markets going forward. John, you touched on the fact that we're in Miami. We are looking at the beach. We've been holed up in the Northeast, you and I for the last couple of months of making it down to hot weather is a bit of a shock. So let's make sure we have our suntan lotion on today and not burn ourselves. Thank you for sharing all this insight on private markets. And thanks for doing it on the bid. Thanks for having me, Oscar. It's been great. Thanks for listening to this episode of The bid. If you've enjoyed this conversation, check out our episode on alternative investments, where we take a look at the asset classes that are increasingly becoming a focus for investors looking to diversify. Subscribe to The bid, wherever you get your podcasts. This content is for informational purposes only and is not an offer or solicitation. 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