Strategic Asset Allocation Revisited: The Role of Private Markets

May 12, 2020

Since at least the late 1990s, institutional investors have been allocating more capital to private markets. For some, the low-interest rates that have come to characterize markets following the GFC served as the catalyst; others believed that returns from equities would moderate along with global GDP growth.

Before the surge in popularity of private markets, the core-satellite approach to portfolio construction was appropriate. Composed primarily of low-cost investments, the core related to an institution’s strategic asset allocation. Private markets, however, were regarded purely as alpha-generating satellites—strategies that were still too exotic to be anything more than tactical deployments.

Our approach to deriving an SAA for private markets is not a plug-and-chug operation. Rather, we describe a series of intuitive steps that we hope make the process less intimidating and more transparent. At every step, portfolio management teams need to choose certain inputs and models, and to master success factors.

In light of the recent volatility in public markets, we thought it an opportune time to share some updates to our framework for SAA.

In the first edition of this paper, we focused on building the private markets portfolio on the assumption its size, return objective, and risk budget is determined in a prior phase. But as we pointed out in the first report, public and private asset classes have key risk factors in common and that we believe portfolio managers must take these commonalities into account.

The updated report discusses this aspect of portfolio construction in more detail and illustrates the importance of determining the allocation to public and private markets in conjunction with one another.

More SAA Insights the Full Report

Tom Keck and Christian Frei discuss some of the data-related and analytical challenges investors face when building private market portfolios.