Module 4: Supporting client needs through public-private solutions 4.1 The “modern diversified portfolio”

This video explores how public-private solutions can come together as part of a holistic portfolio strategy and answers the question: What is the “modern diversified portfolio”?

Wesley Phoa

Solutions portfolio manager at Capital Group

Victoria Quach

Senior client analytics manager at Capital Group

7MINVIDEO

[upbeat music]

 

Wesley Phoa, Solutions portfolio manager at Capital Group

 

Wesley: The investment landscape keeps changing, and it’s important to evolve with it to help your clients pursue their objectives over the long term.

 

When we think about constructing a modern diversified portfolio, we take a holistic approach that allows broader access to the investment universe.

 

Victoria Quach, Senior client analytics manager at Capital Group

 

Victoria: That’s right, Wesley. Asset classes like private credit and private equity, once viewed as “alternatives,” have matured and evolved. They’re now more accessible to more investors, as semi-liquid solutions, offering blends of public and private markets. 

 

That increase in accessibility has prompted financial professionals to consider semi-liquid allocations in more of their clients’ portfolios. But for those who are newer to private markets investing, it can be difficult to know how to start.

 

So, even for investors who currently have exposure to private asset classes, these new semi-liquid solutions could be an interesting opportunity to augment their core portfolios. So, let’s discuss a few ways to incorporate semi-liquid holdings and provide some strategies for different types of allocations.

 

- Sounds great.

 

[upbeat music] 

 

- Before allocating to private investments, it’s important to understand if your firm has guidance on how much you might invest in certain asset classes or funds.

 

Wesley, how would you and the Capital Solutions Group consider this type of guidance? 

 

- Many firms have a limit of, for example, 15% in a single fund, and limits on total allocations to private markets. These two guidance limits align with one of our principles in building portfolios, which is having fund diversification and having diversified exposures. When we think through how to allocate, we can consider this guidance and still find opportunities to pursue various portfolio goals.

 

- Now let’s discuss some sample personas and potential allocations. In each case, we’ll consider the potential trade-offs for exchanging some liquidity for the potential of greater returns, diversification and expanded opportunities. For each investor profile, we’ll highlight key characteristics that influence the asset class decision, including risk capacity, time horizon and liquidity needs. 

 

Let’s dive in.

 

Imagine a growth-oriented investor at the start of their career. They have a long time horizon and a strong risk appetite and are more comfortable with significant market volatility and limited liquidity in pursuit of maximum capital appreciation. Wesley, what might a portfolio for that person look like?

 

- In the past, an individual like that might have a 100% allocation to public equities, trying to pursue maximum growth potential. By taking 15% of that portfolio and allocating it to semi-liquid equity strategies, we believe the portfolio could have enhanced return potential without trading away too much in liquidity. Capital Group KKR U.S. Equity+ combines public and private equities into one integrated solution and is worth considering for that allocation. 

 

- What about a more conservative investor? Perhaps someone who is already retired, more interested in capital stability and steady income than growth potential. Given their medium risk, illiquidity capacity and shorter time horizon, any ideas for them? 

 

- Absolutely. Someone in that stage might be more sensitive to liquidity risks and market volatility. They’d probably have a modest equity allocation, maybe of around 20%. For that individual, semi-liquid equity might not be the best fit. Semi-liquid fixed income, however, might be compelling. Our Public-Private+ Solutions suite currently includes two semi-liquid fixed income funds.

 

- Capital Group KKR Core Plus+ and Capital Group KKR Multi-Sector+.

 

- That’s right. Taking that 80% fixed income allocation and putting 10% of it to work in Core Plus+ may provide benefits in the form of enhanced diversification and income potential. 

 

- Ok, now what about someone in the middle? A mid-career investor seeking to build long-term wealth while generating stable income. Someone with some appetite for risk, but who wants downside protection. Might it make sense to include semi-liquid equity and semi-liquid fixed income? 

 

- Absolutely. We view private credit and private equity, and especially our suite of Public-Private+ Solutions, as extensions of traditional allocations. We’ve done research to suggest that many investors may be able to tolerate more illiquidity in their portfolios than they might think. But even modest allocations to these solutions could provide higher potential returns. This combination of public and private, equities and fixed income, is what we mean be a “Modern diversified portfolio.”

 

- So, in this case, let’s imagine a 65/35 split of stocks and bonds, a fairly common portfolio mix. Where would public-private solutions fit into each sleeve of that?

 

- On the equities side, you might consider doing 56% public equity and 9% semi-liquid. For fixed income, 30% to public fixed income would leave you with 5% for semi-liquid products. 

 

- If an advisor wanted to use our funds, that would be Capital Group KKR U.S. Equity+ and Capital Group KKR Multi-Sector+. These are a lot of interesting opportunities to consider. 

 

- Portfolio construction is an interesting field! Every investor has their own objectives and risk tolerances, so, no two clients can be handled the exact same way. 

 

- That’s right. Financial professionals should take care to ensure that the portfolios they’re building are appropriate for a given client. Thoughtful due diligence is essential. 

 

- And an understanding of what your options are is a critical part of due diligence. Thanks for watching. 

 

[upbeat music]

 

Deepen your understanding

Select each resource below to learn more.

The investment landscape keeps changing, and it’s important to evolve with it to help your clients pursue their objectives over the long term. When we think about constructing a modern diversified portfolio, we take a holistic approach that allows broader access to the investment universe.

 

Asset classes like private credit and private equity, once viewed solely as “alternatives,” have matured and evolved. They’re now more accessible to more investors, as semi-liquid solutions, offering blends of public and private markets. That increase in accessibility has prompted financial professionals to consider semi-liquid allocations in more of their clients’ portfolios. But for those who are newer to private markets investing, it can be difficult to know how to start.

 

At Capital Group, we view private credit and private equity, and especially our suite of Public-Private+ Solutions, as extensions of traditional allocations. We’ve done research to suggest that many investors may be able to tolerate more illiquidity in their portfolios than they might think. But even modest allocations to these solutions could provide higher potential returns. This combination of public and private, equities and fixed income, is what we mean be a “Modern diversified portfolio.”

 

Consider the following hypothetical portfolios:

 

Let’s consider a growth-oriented investor at the start of their career: someone with a long-time horizon and a strong risk appetite who is comfortable with significant market volatility and limited liquidity in pursuit of maximum capital appreciation.

 

In the past, an individual like that might have a 100% allocation to public equities, trying to pursue maximum growth potential. By taking 15% of that portfolio and allocating it to semi-liquid equity strategies, we believe the portfolio could have enhanced return potential without trading away too much in liquidity. For that allocation, Capital Group KKR U.S. Equity+ combines public and private equities into one integrated solution.

 

For illustrative purposes only.

 

A more conservative investor: someone who is already retired, more interested in capital preservation and steady income than in growth potential, might have a modest equity allocation of 20%. For that individual, semi-liquid equity might not be the best fit. However, a 10% Capital Group KKR Core Plus+, 20% Public equity and 70% Public fixed income allocation may provide benefits in the form of enhanced diversification and income potential.

For illustrative purposes only.

 

For that investor in the middle: a mid-career investor with some appetite for risk, seeking long-term wealth, income and a measure of downside protection, 5% Capital Group KKR Multi-Sector+, 9% Capital Group KKR U.S. Equity+, 30% Public fixed income and 56% Public equity allocation.

For illustrative purposes only.

Checkpoint

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

 

  • Identify when and how to incorporate semi-liquid public-private solution in your clients’ portfolios as extensions of traditional allocations.
  • Discuss potential portfolio adjustments that can improve diversification and potential returns, while considering each client’s liquidity needs and risk tolerance.

Takeaways

Modern diversified portfolio

Download

End of lesson

The next lesson will help you gain a stronger understanding of semi-liquidity, including the relationship between lower liquidity and higher returns.

NEXT LESSON

For financial professionals only. Not for use with the public.

Investments are not FDIC-insured, nor are they deposits of or guaranteed by a bank or any other entity, so they may lose value.
Investors should carefully consider investment objectives, risks, charges and expenses. This and other important information is contained in the interval fund prospectuses, which can be obtained from a financial professional and should be read carefully before investing.
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.

- Investment strategies are not guaranteed to meet their objectives and are subject to loss. Investing in the fund is not suitable for all investors. Investors should consult their investment professional before making an investment decision and evaluate their ability to invest for the long term. Because of the nature of the fund's investments, the results of the fund's operations may be volatile. Accordingly, investors should understand that past performance is not indicative of future results.

- Investing outside the United States involves risks, such as currency fluctuations, periods of illiquidity and price volatility. These risks may be heightened in connection with investments in developing countries.

- 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.

- The fund is a non-diversified fund that has the ability to invest a larger percentage of assets in the securities of a smaller number of issuers than a diversified fund. As a result, poor results by a single issuer could adversely affect fund results more than if the fund were invested in a larger number of issuers.

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.
This material does not constitute legal or tax advice. Investors should consult with their legal or tax advisors.
Statements attributed to an individual represent the opinions of that individual as of the date published and do not necessarily reflect the opinions of Capital Group or its affiliates. This information is intended to highlight issues and should not be considered advice, an endorsement or a recommendation.
Capital Group and Kohlberg Kravis Roberts & Co. L.P. (“KKR”) are not affiliated. The two firms maintain an exclusive partnership to deliver public-private investment solutions to investors. KKR serves as the sub-adviser of Capital Group KKR Core Plus+ and Capital Group KKR Multi-Sector+ with respect to the management of each fund's private credit assets. KKR is not a sponsor, promoter, investment adviser, sub-adviser, underwriter or affiliate of Capital Group KKR U.S. Equity+.
All Capital Group trademarks mentioned are owned by The Capital Group Companies, Inc., an affiliated company or fund. All other company and product names mentioned are the property of their respective companies.
Use of this website is intended for U.S. residents only. Use of this website and materials is also subject to approval by your home office.
Capital Client Group, Inc.
This content, developed by Capital Group, home of American Funds, should not be used as a primary basis for investment decisions and is not intended to serve as impartial investment or fiduciary advice.