MODULE 3: PUBLIC-PRIVATE EQUITY 3.3 Allocating to public-private equity

In this video, we begin to think about how one might allocate to a public-private equity solution. We will discuss potential portfolios to consider for clients with different objectives, risk capacities and time horizons.

Jan Gundersen

Head of wealth solutions at Capital Group

4MINVIDEO

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Jan Gundersen, Head of wealth solutions at Capital Group

 

Hello and welcome. In this video, we’ll start thinking about what role private equity might play in a client’s portfolio, particularly when blended with public equity. 

 

For a long time, private equity was principally the domain of institutional investors and ultra high net worth individuals due to high investment minimums and strict investor eligibility requirements. But as private equity has matured as an asset class, the landscape has shifted. 

 

New products have come to market that make private equity potentially more accessible to a broader swath of investors. One example of these new products is solutions that combine public and private equity into one integrated strategy that may allow more investors to include private markets exposure in their core portfolio. 

 

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There are multiple reasons why someone might be interested in private equity, including the potential for enhanced returns and added portfolio diversification. If you’ve decided to add some private equity exposure, your first question might be: how should I think of where this sits in my portfolio?

 

Historically, private equity and other private market asset classes have been thought of as “alternatives” – not stocks, not bonds, but something different. In our view, that may no longer be the case. Instead, we view private equity as part of the larger equity continuum. When thinking of where to source funding for your private equity allocation, we believe it could sit at the core of a client’s portfolio, as an extension of their overall equities’ exposure.

 

That might help you think of where to consider this exposure fitting in. But how much exposure is appropriate? As with any exercise in portfolio construction, you have to consider a client’s objectives, risk capacity and a host of other factors in order to make the most appropriate decisions for them. Let’s explore some possible scenarios.

 

Imagine a client who is early in their career. They have a long time horizon, a high tolerance for illiquidity and a sizable appetite for risk. Perhaps their current portfolio is 100% public equities. 

 

For an investor like that, whose primary objective is long-term growth of capital, a 15% allocation to a blended public-private equity solution could be considered. That level aims to balance capital appreciation potential with concentration risk to any specific private equity investment. For the purposes of these examples, we’ll use Capital Group KKR U.S. Equity+ for that semi-liquid private equity exposure. 

 

Consider another example: A hypothetical client who is a little further in their career, maybe a little closer to retirement, but still with an interest in long-term growth. This investor might be willing to take on illiquidity but is more risk-averse than the previous example and a bit more interested in managing volatility.

 

Instead of a portfolio entirely composed of equities, that kind of investor may be closer to a 65/35 stock-to-bonds allocation. There’s still room there to add some private markets exposure. Carving out 9% for Capital Group KKR U.S. Equity+ might offer potential benefits in the form of higher total return potential and diversification of portfolio growth drivers.

 

There is no one-size-fits-all approach when it comes to building client portfolios. Private markets exposure may not be appropriate for every client, and if you do feel an allocation is appropriate, the exact amount can vary notably from client to client. 

 

In the accompanying lesson materials, we’ll share a few more ideas about how a potential portfolio could look.  We hope you’ll find that helpful, and we thank you for watching.

 

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Every investor is different, and comes with their own financial goals, expectations and appetite for risk. For those who can tolerate less liquidity in exchange for potentially higher returns and more diversification, an integrated solution that combines public and private equity may be an attractive way to diversify a portfolio. Such a semi-liquid allocation could increase a portfolio’s capital appreciation potential while mitigating some of the risks of a more illiquid, pure private equity allocation.

Consider the following hypothetical portfolios:

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Investors with a higher tolerance for risk, a longer time horizon and/or a greater ability to withstand illiquidity may benefit from an allocation to semi-liquid equity of around 15%. This might be appropriate for investors who are chiefly focused on capital appreciation opportunities. For this example, we will use Capital Group KKR U.S. Equity+ for that allocation. More information on that fund is available in other lessons.

In the middle of the risk capacity spectrum, you’ll find a portfolio that may be suitable for investors who have some tolerance for market volatility but may be in a phase of life where they have short-term spending commitments to think about. Investors such as this will likely still want their portfolio to have growth potential, but may have a shorter time horizon and lesser ability to withstand illiquidity. We believe a 9% allocation to Capital Group KKR U.S. Equity+ may be the right amount to try to balance those goals.

For clients in or near retirement, whose goals focus more on capital preservation than appreciation, you may consider a gradual decrease in allocation to Capital Group KKR U.S. Equity+ over time, depending on objective, risk tolerance and time horizon. 

That doesn’t mean there aren’t opportunities to introduce private markets exposure elsewhere in the portfolio, however. These hypothetical portfolios focus on public-private equity, but their fixed income segments can also include public-private solutions.

Checkpoint

Now that you have completed this lesson, you should be able to confidently:

 

  • Identify opportunities to add value through public-private equity solutions by analyzing client objectives, risk tolerance and investment horizon.
  • Communicate risk/benefit trade-offs of public-private equity solutions so your clients can make informed decisions.
  • Assess portfolio allocation strategies that combine public and private equity, including semi-liquid solutions, tailored to different investor profiles.

Takeaways

Allocating to public private equity

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End of lesson

The next lesson will introduce you to the Capital Group KKR Public-Private Equity+ Fund, including the fund specifics and the philosophy behind it.

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For Public-Private+ Funds: Capital Group KKR Core Plus+ and Capital Group KKR Multi-Sector+ are interval funds that currently provides liquidity to shareholders through quarterly repurchase offers of up to 10% of its outstanding shares. Capital Group KKR U.S. Equity+ is an interval fund that currently provides liquidity to shareholders through quarterly repurchase offers of 5% of its outstanding shares. To the extent a higher percent of outstanding shares are tendered for repurchase, the redemption proceeds are generally distributed proportionately to redeeming investors (“proration”). Due to this repurchase limit, shareholders may be unable to liquidate all or a portion of their investment during a particular repurchase offer window. In addition, anticipating proration, some shareholders may request more shares to be repurchased than they actually wish, increasing the likelihood of proration. Shares are not listed on any stock exchange, and we do not expect a secondary market in the shares to develop. Due to these restrictions, investors should consider their investment in the fund to be subject to illiquidity risk.

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- Illiquid assets are more difficult to sell and may become impossible to sell in volatile market conditions. Reduced liquidity may have an adverse impact on the market price of such holdings, and the fund may be unable to sell such holdings when necessary to meet its liquidity needs or to try to limit losses, or may be forced to sell at a loss. Illiquid assets are also generally difficult to value because they rarely have readily available market quotations. Such securities require fair value pricing, which is based on subjective judgments and may differ materially from the value that would be realized if the security were to be sold. Situations involving uncertainties as to valuation of assets held by the fund could have an adverse effect on the returns of the fund.

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For Public-Private Credit+ Funds:

- Bond investments may be worth more or less than the original cost when redeemed. High‐yield, lower‐rated, securities involve greater risk than higher‐rated securities; portfolios that invest in them may be subject to greater levels of credit and liquidity risk than portfolios that do not.

- The funds may invest in structured products, which generally entail risks associated with derivative instruments and bear risks of the underlying investments, index or reference obligation. These securities include asset-based finance securities, mortgage-related assets and other asset-backed instruments, which may be sensitive to changes in interest rates, subject to early repayment risk, and their value may fluctuate in response to the market's perception of issuer creditworthiness; while generally supported by some form of government or private guarantee, there is no assurance that private guarantors will meet their obligations.

- While not directly correlated to changes in interest rates, the values of inflation-linked bonds generally fluctuate in response to changes in real interest rates and may experience greater losses than other debt securities with similar durations. The use of derivatives involves a variety of risks, which may be different from, or greater than, the risks associated with investing in traditional securities, such as stocks and bonds.

- The fund invests in private, illiquid credit securities, consisting primarily of loans and asset-backed finance securities. The fund may invest in or originate senior loans, which hold the most senior position in a business's capital structure. Some senior loans lack an active trading market and are subject to resale restrictions, leading to potential illiquidity. The fund may need to sell other investments or borrow to meet obligations. The funds may also invest in mezzanine debt, which is generally unsecured and subordinated, carrying higher credit and liquidity risk than investment-grade corporate obligations. Default rates for mezzanine debt have historically been higher than for investment-grade securities. Bank loans are often less liquid than other types of debt instruments and general market and financial conditions may affect the prepayment of bank loans, as such the prepayments cannot be predicted with accuracy.

For Public-Private Equity+ Funds:

- The fund also intends to concentrate in the financial services group of industries, and to invest at least 80% of its assets in securities issued by companies based in the United States.

- K-PEC and co-investment risks: The fund's investments in KKR Private Equity Conglomerate LLC (“K-PEC”) and co-investments alongside K-PEC or one or more other KKR vehicles that pursue private equity strategies entail additional risks. Private equity investments are typically illiquid, speculative, and difficult to value, often requiring multi-year holding periods with returns generally realized only upon sale or refinancing of a portfolio company. These investments depend on access to financing, and market disruptions or increased competition may limit opportunities and affect performance. The fund's significant investment in K-PEC creates concentration risk and a decline in K-PEC's value could materially impact the fund's returns. Co‑investment opportunities are competitive and limited and there is no assurance the fund will receive allocations or comparable terms and will generally have less information than for public companies. Through its investments in K-PEC or other KKR Vehicles and co-investments, the fund may have exposure to portfolio companies with limited operating histories, evolving markets, unproven technologies, and inexperienced management, which may require significant capital and create heightened vulnerability to downturns. Most holdings are illiquid, subject to resale restrictions and may require consents or be sold at a discount. Costs associated with investments in private equity are generally greater than those of investments in other asset classes. In addition to bearing their portion of the fund's fees and expenses, shareholders in the fund will indirectly bear a portion of the asset-based fees, incentive fees and other expenses incurred by the fund as an investor in K-PEC or other KKR Vehicles and in co-investments. Incentive fees are paid to KKR when the fund's investments in K-PEC or other KKR Vehicles and/or co-investments deliver returns in excess of a specified hurdle; when paid, these fees reduce the net realized returns of such investments.
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