2024 seems to be following the same pattern, with additional curveballs such as August’s yen “carry trade unwinds” adding to investor unease. Still, there are numerous reasons to believe that the differing policy platforms of Democratic presidential nominee Kamala Harris and Republican presidential nominee Donald Trump will have limited long-term impact on markets. Even in the event of a sweep by one party, both candidates have policy goals that may be constrained by wider market conditions and that contain inherent contradictions. For example, boosting US energy supply may depend on global oil supply/demand dynamics, most of which are outside a president’s control. Increasing the supply of goods while limiting their prices may also prove self-defeating. Despite the potential for deficits to increase under either candidate, interest rates may still decline as growth slows and inflation continues to ebb. Finally, there also may be more shared political ground than is realized regarding the fate of legislation such as the 2017 Tax Cuts and Jobs Act.

The following sections discuss our views on five common election-related narratives in the marketplace today. Specifically, we discuss how:

• Stock market volatility may rise as the election approaches and policy uncertainty grows but historically settles down post event.
• Discounted relative valuations and a rebound in earnings growth for some companies are more likely to spark a rotation in equity style factors than politics.
• Regardless of the election result and despite elevated deficits, we expect fading inflation and slowing growth will be good for bond investors.
• A “red wave” should temporarily boost the US dollar but eventually stretched valuations and the Fed following its global peers with rate cuts will lead to the currency’s decline.
• On climate, a Harris win will mean more investment, while a Trump win may mean some regulations are rolled back; however, legislation like the Inflation Reduction Act (IRA) will be difficult to roll back, given its established law and broadly distributed benefits.

A common thread of the sections is that we believe that the macro environment and valuations will be larger drivers of investment outcomes than the election. This is not to say that certain election outcomes don’t create some specific winners and losers; for example, smaller companies could benefit more from tax cuts under a red wave. Nor is it to argue that sequencing doesn’t matter—markets may remain volatile after the election if new policies that are negative for markets (e.g., tariffs) are implemented before other positives (e.g., corporate tax cuts). Still, given that market focus eventually returns to fundamentals, and everything that is promised by politicians is not always delivered, we do not recommend making asset allocation changes due to perceived election outcomes.

Market Narrative #1: Volatility Will Be Elevated Around the Election

We agree with this marketplace narrative. The CBOE Volatility Index (VIX), which is a measure of expected short-term equity volatility, has tended to increase in the months leading up to US presidential elections, with a notable increase approximately two months before election day. This rise in volatility is due to investor unease about potential policy changes and media amplification of political events. However, this heightened volatility usually subsides immediately after the election, as the resolution of uncertainty allows investors to assess the new administration’s impact on capital markets.

For much of 2024, the VIX traded at very low levels, averaging less than 14 from January through July, well below its long-term average of 19.5. However, October VIX futures indicate that investors have expected higher volatility near the election, as these futures have been priced around 13% higher than September futures since they started trading in January.

Recently, the VIX spiked due to concerns about US economic weakness and unknown risks linked to an unwinding of the yen carry trade. Broader economic issues like these often drive market volatility more than election concerns. For example, the 2008 Global Financial Crisis intensified about a month before the presidential election, overshadowing election jitters.

Investors should expect volatility around the US presidential election to remain high relative to this year’s typical level. While there can be other catalysts that drive stock market turbulence to a greater degree than politics, it is worth remembering that equity markets are often in better shape just one year after the election. In fact, since 1980, there has only been one election year where the S&P 500 was lower 12 months after the election—2000, amid the implosion of the dot-com bubble.

Market Narrative #2: The US Election Result Will Trigger an Equity Style Rotation

We disagree with this marketplace narrative. We don’t think the US election results will be the main driver of a major equity market rotation. Instead, we believe that valuations, fundamentals, and the changing macro environment are more likely to drive relative performance.

Recent months have seen signs of slowing economic growth, ebbing inflation, and a nascent rotation in the US equity market. Previous winners, such as large-cap growth stocks, have underperformed, given concerns over valuations and payoffs for AI-related investment, while simultaneous growing expectations of future Fed easing have boosted demand for previous laggards like small-cap equities and value stocks.

At first blush, certain aspects of the economic platforms of the main candidates could be viewed as accelerating these macro changes and thus quickening this rotation. For example, Democratic pledges to extend most household tax cuts could boost revenues for more cyclical value stocks, while Republican promises to further reduce corporate tax rates could boost margins of small US companies, which have higher effective tax rates. In the same vein, Republican promises of lighter regulatory oversight could boost value sectors such as energy and financials.

But history cautions against simplified narratives and ignoring fundamentals or valuations. Recall, for example, that despite similar pledges around eight years ago, the first Trump presidency saw energy stocks underperform. Conversely, these (oversold) energy companies rebounded, while (expensive) clean energy stocks lagged during the Biden administration despite passage of the IRA. More broadly, given many Russell 2000® companies are unprofitable, it is not clear how much they would benefit from further reduction in corporate tax rates.

Looking ahead, we think a rotation toward high-quality US small-cap companies and value stocks is more likely to be driven by deeply discounted relative valuations and a rebound in earnings growth as opposed to being weighted on a particular political outcome. Small caps in particular are expected to post weaker earnings growth in 2024, but a lower base means profit growth should recover under most potential economic and political outcomes next year. Expected rate cuts will help by lowering debt servicing costs. While potential election outcomes could influence regulations and legislation that benefit some sectors more than others, absent a crystal ball we continue to rely instead on time-tested valuations and fundamentals.

Market Narrative #3: One Party Sweeping the Election Will Be Bearish for US Treasury Securities

We disagree with this marketplace narrative. While a unified government ¹ might lead to slightly larger deficits, it does not change our view that the US economic cycle will likely support US Treasury performance over the next one to two years. Consequently, we do not recommend reducing allocations to high-quality US bonds, and we still see value in maintaining duration at a total portfolio level.

The belief that a unified government will be bearish for US Treasury securities assumes this outcome will lead to greater fiscal expansion, increased Treasury supply, and higher yields. Similar concerns led to ten-year Treasury yields surging nearly 100 basis points after the 2016 election. More recently, concerns about deteriorating public finances in developed markets have added to bond market volatility. However, studies show that the historical relationship between government debt and yields is relatively weak. Yields tend to be more sensitive to economic fundamentals and changes in monetary policy expectations. Additionally, the poor US fiscal outlook is well-known, and the CBO’s latest projections suggest the election outcome will have a limited impact on the current trajectory of US public finances.

Tariffs are another concern, with former President Trump proposing a 10% tariff on all imports into the United States. Estimates suggest this would increase annual core inflation by around 1 percentage point. ² However, this is a one-time price boost that will drop out of the annual figures after one year. In theory, the Fed should look through the price impact of tariffs, especially if it is weighing them against a continued cooling in the labor market, as we expect.

While the election could contribute to increased bond volatility and higher interest rates in the short term, it is important to remember that the election does not happen in a vacuum. Over the course of a full presidential term, we would expect the underlying economic cycle to be the more important driver of Treasury yields. In that regard, we expect continued moderation in US inflation, cooling in the labor market, and the Fed embarking on an easing cycle to support US Treasury securities.

Market Narrative #4: A Red Wave Will Strengthen the Dollar

We agree that a Republican sweep could initially strengthen the dollar. Implementation of the Trump administration’s proposed policies, including the imposition of tariffs on imports and a sweeping reduction in immigration, would provide support to the dollar. A Republican-controlled Congress delivering looser fiscal policy ³ would also serve as a bolster. However, we believe this boost would likely prove transient, with the broader cyclical backdrop being the more significant driver and auguring for a longer-term decline.

Both economic theory and the precedent of the prior Trump administration suggest that the imposition of trade tariffs would tend to strengthen the dollar. In the first instance, there is a competitiveness adjustment in the currencies of impacted markets, as a new competitive equilibrium is found. This process would tend to support the dollar versus its peers, at least initially, due to the less trade-dependent nature of the US economy. Additionally, while a tariff-driven price rise should be a one-off, market interest rates could still move higher in response, particularly given the context of recent elevated inflation. Limiting immigration could also impact interest rates by capping the supply of labor, which would benefit the dollar. A Republican sweep of Congress—which is not currently expected—could be more growth supportive in the short run than the counterfactual, potentially bolstering the dollar as expectations adjust.

However, we expect the underlying cyclical backdrop to be the more important driver of the currency over the course of a full presidential term. In this regard, and with the dollar still richly valued, more balanced global growth and the Fed following its peers into a rate-cutting cycle should see the dollar decline. Additionally, cutting immigration reduces potential growth, while tariffs essentially function as a tax on the consumer and should eventually weigh on growth and inflation if not offset in some way. Though a unified Republican Congress is likely to deliver some offsets, they are unlikely to have the type of durable impact on growth that may be needed to support the dollar more structurally. Finally, Trump has spoken often about his concerns over the strength of the dollar and his desire to revive domestic manufacturing via a weaker currency. Explicit intervention to weaken the dollar looks unlikely, but jawboning could eventually have some impact when it aligns with the direction justified by fundamentals.

Market Narrative #5: A Harris Presidency Will Permit Greater Climate Investment

We agree with this marketplace narrative. Kamala Harris is expected to continue implementing the IRA, with a substantial portion of its funding still available for climate investment. She may have the opportunity to expand climate initiatives if Democrats secure majorities in both chambers of Congress.

The Biden administration has championed climate-friendly initiatives, including rejoining the Paris Agreement and passing the IRA, which represents the largest investment in addressing climate change in US history. As vice president, Harris was closely involved in the rollout of the IRA, and her continuation of this policy will likely be a top priority for her administration. The IRA is expected to accelerate decarbonization; models project that it could contribute to an average 37% reduction in US greenhouse gas emissions by 2030 compared to 2005 levels. ⁴ However, these initiatives may fall short of the US commitment to cut emissions by 50% by 2030 compared to 2005 levels.

Harris may not just continue President Biden’s climate policies but could seek to expand them if the opportunity arises. For example, Democrats have hinted at a desire to expand clean energy tax credits beyond what has already been established in the IRA. Harris’s ability to drive a more ambitious climate policy will depend on the balance of power in Congress, as significant changes to climate legislation would require approval by both the House of Representatives and the Senate.

By comparison, a Trump presidency would focus on scaling back renewable energy policy. With a second term, Trump could be more effective in repealing some climate-related regulations due to more experienced staff and a judiciary that may be more favorable to deregulation efforts. However, Trump’s ability to fully reverse climate investment trends is limited. Significant climate and energy investments, such as those in the IRA and the Infrastructure Investment and Jobs Act, are established by law and would be difficult to repeal. These laws have bipartisan support, especially in areas benefiting from the investments. Furthermore, the broad trend toward clean energy and decarbonization is driven by market forces and technological advancements, which are likely to continue regardless of political changes.

Navigating Narratives, and Staying the Course

Looking ahead, investors should remain focused on long-term drivers of asset prices rather than getting swayed by political noise. While we expect higher volatility near the election, it should subside once the immediate uncertainties are resolved. Certain asset classes may come under more pressure in some election outcomes, given the potential policy implications. For example, higher tariffs are likely a near-term headwind for US Treasury securities and non-US stocks, all else equal. Still, even in these instances, we expect other factors—such as the current macro environment, fundamentals, and valuations—will likely outweigh any policy-related impact on asset prices over the course of a full presidential term.

As such, we do not believe investors should position portfolios in response to any one election outcome. Instead, we believe investors are best served by relying on a well-constructed asset allocation, sticking to any predetermined rebalancing policy, and monitoring liquidity sources and needs to navigate and potentially take advantage of any dislocations in asset prices around the election.

Sean Duffin, Senior Investment Director, Capital Markets Research
Wade O’Brien, Managing Director, Capital Markets Research
Thomas O’Mahony, Senior Investment Director, Capital Markets Research
TJ Scavone, Senior Investment Director, Capital Markets Research

Other contributors to this publication include Drew Boyer and Graham Landrith.

Footnotes

1. A unified government occurs when one party wins the White House and both houses of Congress.
2. Please see Jan Hatzius et al., “The Effect of Tariffs on Government Revenue, Growth, and Inflation: Lessons From the Last Trade War,” Goldman Sachs Economic Research, April 6, 2024.
3. See, for instance, the Penn Wharton Budget Model which estimates that Trump’s tax and spending proposals would increase the primary deficit by $1,548 billion between 2025 and 2028, in comparison to the estimated $711 billion increase that would result from Harris’ proposals.
4. John Bistline et al., “Emissions and Energy Impacts of the Inflation Reduction Act,” Science, Vol 380, Issue 6652 (30 June 2023): 1324–1327.

The post US Election Anxiety: Keeping Calm Amid Political Uncertainty appeared first on Cambridge Associates.

In this edition of VantagePoint, we find that consumers, corporations, and the banking sector remain in good shape, and while US/global economic growth is likely to slow in the second half of 2024 relative to the first, we expect it will remain positive. Although market concentration risk is elevated, given its focus on highly profitable AI-related tech stocks, we would seek to be measured about diversifying such risks. We recommend modest, risk-controlled tilts away from mega-cap tech stocks toward more attractive developed markets small-cap and value stocks. We review the importance of consistent risk management practices including diversification and liquidity management. Fortunately, there are attractive investments that can provide portfolio resilience and be additive to long-term performance. Further, liquidity management can help investors maintain their strategic direction in the face of equity market downturns by providing confidence in the ability to meet cash needs for spending, taxes, rebalancing, and capital calls.

Keeping Track of the Plot

Markets have been laser focused on economic data, creating volatility around data releases. Leveraged and crowded positions have been particularly vulnerable, especially as the unwinding of the Japanese yen carry trade led to deleveraging and general de-risking.

Change has been afoot since the surprisingly soft July 11 US Consumer Price Index report sparked a market rotation. As Treasury yields fell amid rising expectations of US central bank easing and a soft landing, unloved small-cap stocks and global value stocks outperformed the AI darlings that had dominated the market. US small-cap stocks were also boosted by rising expectations for a Trump presidency and a Republican sweep of Congress prior to President Biden pulling out of the race.

The tide shifted again on August 2 after a weak US labor report renewed recession expectations. The Japanese yen carry trade unwound as the yen spiked, supported by tighter interest rate differentials between US Treasuries and Japanese government bonds that had already begun narrowing after a Bank of Japan (BOJ) rate hike in late July. As equities broadly sold off, mega-cap tech stocks did not resume their leadership. For the first five days of August, both the Magnificent 7 (Mag 7) and US small caps underperformed equities outside the United States, while Japanese equities suffered disproportionately. US Treasury yields proved defensive, with the ten-year yield falling more than 20 basis points during the depths of the equity sell-off.

Equity markets have largely returned to previous levels, although mega-cap tech stocks and Japanese equities remain below recent high-water marks. The recovery was helped along as BOJ officials sought to settle markets by signaling a gradual approach to monetary policy tightening that is sensitive to volatility, and firmer US data releases also supported markets.

Slowing Inflation and Softening Economic Data

Global economic data have been holding up well this year as inflation has continued to decelerate, although there have been some signs of softening, particularly in China and Europe. Data for the United States have been mixed, but reflective of a slowing economy, not a recession. Recent concerns have focused on the labor market, where the unemployment rate has gradually increased, jobless claims have risen, and job growth has decelerated. Labor market conditions are consistent with an expanding economy, but the rate of change has caused concerns that further deterioration is on the horizon. The Sahm rule has been triggered at a 0.5-percentage point increase in the three-month average unemployment rate from its recent low. This has historically led to a substantial rise in unemployment and eventually a recession. Much of the recent rise in unemployment has been due to increased labor force participation rather than layoffs, putting the utility of the measure in question.

Still, slightly softer growth and a more mixed economic outlook suggest recession risks have risen, as confirmed by consensus expectations. There has also been some deterioration in the weakest segments of the economy, as reflected in the rise in defaults rates on credit cards and non–investment-grade debt.

The Fed has considerable flexibility to address economic weaknesses should a recession develop, with the Fed funds rate target between 5.25% and 5.5%—the highest in 22 years. Furthermore, US households and corporations are in a better position today than they have been heading into previous slowdowns, which should help support growth. For example, the vast majority of US households and investment-grade, non-financial corporations are healthy with reasonable interest coverage. Banks are also better capitalized following increased regulatory requirements, particularly for large, systemically important banks. This could certainly change with a sharp increase in unemployment, but this is not our base case.

Market Concentration and the Magnificent 7

The second major market narrative that has been shifting is the faith in the Mag 7 stocks. This group of stocks is central to the broad market’s performance as it accounts for about 20% of global equities and 30% of the S&P 500 market capitalization. This transformation has been driven by exceptionally strong relative performance. Over the last 15 years, US equities have accounted for 58% of developed markets equity returns, with roughly half of the US return attributable to the tech and interactive media sectors, according to analysis by Empirical Research Partners.

In recent years, returns have been driven by tech stocks’ relative earnings strength, particularly Nvidia and most of the Mag 7. In fact, if you exclude the Mag 7, earnings growth for US stocks have lagged that of other developed markets, although US stocks are expected to catch up again in the next year or two. While earnings growth for the Mag 7 has been exceptional, the scale of capex and research and development (R&D) spending by these firms on AI initiatives have raised doubts about the ability of AI applications to deliver a return on investment that can support continued elevated earnings growth.

Investors are right to be concerned. Disruptive innovation cycles create vast opportunities, the scope and timing of which are difficult to estimate. During the technology and telecommunications boom, real capital expenditures increased at a rate of 12% per year from 1991 to 2000. As much as 95% of installed fiber-optic cable remained unused immediately following the bursting of the technology, media, and telecom (TMT) bubble, which forced overleveraged telecommunications out of business. AI spending has been significant, with Mag 7 capex and R&D spending totaling $419 billion in 2023, accounting for about 20% of S&P 500 capex and 40% of reported R&D with more expected in the next few years.

However, there are important differences between the TMT bubble and the current buildout of AI. In contrast to the overleveraged telecommunications firms of the TMT bust, most of the Mag 7 benefits from high free cash flow margins and squeaky-clean balance sheets. At the height of the tech bubble, TMT stocks were spending more than 100% of operating cash flows on capex and R&D. In contrast, today’s mega-cap tech companies’ capex and R&D as a share of cash from operations is 72%, close to the 40-year median of 67%. Should development of profitable applications using AI disappoint, high valuations will not be sustained. However, investors are not taking a solvency risk, but rather a concentrated risk, which can be managed. Given the strength of these companies and their promising prospects, we would tightly manage underweights, tilting modestly into more attractively valued segments of the market.

A Plethora of Additional Risks

There is no shortage of risks for investors to consider. For example, commercial property markets, particularly office, present opportunities for stress that will intensify should interest rates remain elevated or increase from current levels. High sovereign debt as a share of GDP presents another challenge. Episodes of market stress related to sovereign debt largesse were briefly experienced in the UK gilt market during Liz Truss’s brief stint as prime minister and in the French OAT market around the French parliamentary election. US debt is also elevated; however, as the reserve currency, the United States benefits from steady demand associated with global trade and lending, with no apparent competitor at the ready to displace the US dollar. Volatility tied to disruptive secular forces like AI transformations, climate change and energy transition, shifting supply chains, inflation, and broader geopolitical and political strains also pose risks. These risks will likewise bring opportunities for investors that closely study the shifting landscape and partner with asset managers that bring diverse perspectives that can help identify varied opportunities in a changing and dynamic landscape.

Key Components of Risk Management

While economic conditions appear solid, economic growth has slowed and default rates on weak credits have increased even as they remain low. The severity of the yen carry trade unwinding—while brief—highlights that risks can accumulate in the system and manifest unpredictably. The foundation of a successful investment strategy is careful portfolio construction and liquidity risk management, not rash reactions to market volatility.

Layer Diversification

Well-constructed portfolios are designed to meet long-term and near-term return objectives, while maintaining adequate diversification and liquidity sources to manage through challenging downturns. Too much diversification into ultra-safe assets, and portfolio return objectives may not be met, while too little could result in permanent loss of capital if a meaningful share of risky assets must be sold at depressed prices to meet spending needs.

The most reliable and efficient form of portfolio diversification is high-quality bonds, particularly US Treasury yields. Given these diversification characteristics and reasonable valuations at current yields, we recommend maintaining a neutral exposure to Treasury yields relative to policy targets. Cash can also provide more stability, but generally at a high opportunity cost. Holding cash has been additive to portfolios as the yield curve has been inverted, but low long-term return expectations and the lack of upside potential during periods of stress make longer-duration Treasury yields a more useful diversifier.

Inflation-linked sovereign bonds (ILBs) provide an interesting supplement to nominal sovereign bonds today, given still-elevated real yields and their ability to serve as a viable hedge against inflation, while also contributing to portfolio resilience in a variety of economic outcomes. ILBs are less volatile and higher returning than most inflation-sensitive assets, but they are less liquid than nominal sovereign bonds and have faced pressure during previous periods of stress. Similarly, global macro hedge funds and trend-following strategies can be useful diversifiers as a second layer of defense in portfolios. Such strategies have the potential to be long volatility when equities are under stress, while trend following can also provide diversification against varied risks, especially for strategies that cover a variety of markets. These strategies are less reliable than high-quality sovereign bonds and require thoughtful manager selection and portfolio construction but are worth the effort in building resilient diversification.

Embrace Optionality

One component of diversification we like today are strategies that offer optionality—good return prospects across the economic cycle with potential to outperform during periods of stress or distress. Equity long/short (ELS) is one such example. ELS hedge funds have increased in appeal in the last year but have seen dwindling portfolio allocations among investors. As we noted in our 2024 Outlook, the lifting of some structural factors that have held ELS hedge funds back since the Global Financial Crisis (GFC)—low interest rates, muted volatility, and exceptional long-only equity returns—have faded. Most notably, the short rebate exceeds dividend yields by the widest margin since 2001, marking a more favorable environment for short sellers. Further, our expectations that weaker economic growth will lead to more dispersion in corporate fundamentals, while secular shifts related to supply-chain adjustments and technological innovation create opportunities for highly skilled managers to add value on the long and short sides of their books, providing diversification to portfolios and adding alpha.

A variety of uncorrelated strategies (e.g., insurance-related strategies) can offer helpful diversification by taking a range of risks less dependent on economic growth. The key challenges with these investments are the steep learning curve required for due diligence and their tendency to be somewhat illiquid. Even seemingly liquid strategies—like many absolute return–oriented hedge funds—chose to gate investors from accessing funds during the stress that followed the GFC. These strategies often need to be thought of as providing long-term diversification rather than as a source of liquidity to tap during times of stress.

Diversify Some Equity Concentration Risk

As noted above, global equities have become increasingly concentrated, making diversification within equities an important part of risk management. The concentration and level of valuation warrants tilting away from these names. Yet, the strength and growth prospects of these companies drives us to do so in a tightly risk-managed fashion. Many portfolios already have sufficient underweights relative to market benchmarks given the use of active managers. Active managers tend to both differentiate bets within Mag 7 names and hold more equal-weighted portfolios. While non-US equities offer cheaper valuations than US equities, US equity valuations are less elevated once we exclude the Mag 7. We expect tilting toward value and small caps in developed markets will add more value to portfolios than overweighting non-US developed markets. Within small caps, we focus on higher quality, particularly in the US market where a greater share of small caps has no—or negative—earnings.

Dynamic Liquidity Management

A critical dimension of risk management is provisioning for cash sources during times of stress to meet spending, tax, capital calls, or rebalancing needs. Portfolios have become less liquid as investors shifted from traditional stocks and bonds to private investments. Endowments with more than $500 million now hold 34% in private investments, up from 23% a decade ago, with uncalled capital commitments equal to 16% of portfolio market value. Larger private equity allocations can enhance returns but also increase illiquidity risks in downturns.

Not only have allocations to illiquid assets increased, but the liquidity of such assets has diminished. For example, the number of years until global venture capital investors receive distributions equal to invested capital has increased from the eight to nine years experienced in 2010–14. On average, global venture capital funds of vintage year 2015 and beyond have not yet reached this milestone. A stagnant IPO market and the preference of many private companies to stay private for longer perpetuate this trend, although the rapid growth of continuation vehicles and the deepening secondary market offer increasing exit opportunities. These shifts necessitate increased liquidity planning, especially for institutions with significant annual spending needs and investments with lock-ups. A slower distribution pace also requires a slowing of commitment pace needed to meet or maintain policy target allocations and the ability for private investment programs to be self-financing.

To properly provision for liquidity needs, investors need to consider three dimensions of liquidity that can shift in times of stress: 1) portfolio liquidity; 2) access to liquidity outside the portfolio from reserves, debt capacity, charitable donations, revenue, or earnings; and 3) spending needs. During market downturns, portfolio asset liquidity diminishes as funds with gating provisions will lower gates, private investments make distributions more slowly relative to the pace of capital calls, and bid-ask spreads of less liquid markets widen, requiring larger discounts to transact. Downturns can have systemic impacts, affecting bond issuers’ credit ratings and increasing borrowing costs. Institutions relying on charitable giving or cyclical revenues may see contributions drop during downturns, just when spending needs rise. Colleges and universities already facing demographic challenges can see their revenues further pressured. Potential changes in tax circumstances should also be considered. Spending needs from long-term assets can increase, especially if other revenue/income sources decline, and at a minimum are likely to remain constant in terms of absolute amounts such that spending represents a higher share of asset values.

Investors with significant allocations to illiquid funds should stress test their portfolios and develop a plan for sourcing and using available liquidity during the next downturn. Our primer on liquidity management can provide a helpful guide to liquidity stress testing.

Conclusion

While economic growth is slowing, the fundamentals of consumers, corporations, and the banking sector remain robust. Recent market volatility underscores the importance of adhering to a well-constructed asset allocation, consistent risk management practices, and vigilant liquidity management. We would maintain strategic exposures to equities while reviewing equity concentration risk, the construction of diversifying assets, and liquidity sources and uses to make sure they are fit for purpose in the current environment.

We would modestly diversify concentration risk in equity markets as AI-related tech stocks offer secular appeal but are richly valued. Using active managers will naturally provide some diversification. Our tactical tilts to more attractively valued developed markets small-cap and value stocks can provide further diversification. As yields have settled at higher levels than we have seen in recent years, a wider range of diverse exposures have become more attractive. High-quality nominal sovereign bonds and ILBs, trend following, and global macro hedge funds offer valuable diversification. Additionally, strategies that provide optionality—such as ELS and less economically sensitive strategies—can enhance portfolio resilience.

Dynamic liquidity management is crucial, especially for investors with significant allocations to private investments. While the current market environment presents numerous challenges, it also offers opportunities for those who are prepared. By focusing on diversification that includes value added opportunities, liquidity management, and strategic asset allocation, investors can build resilient portfolios capable of weathering economic storms and achieving long-term success.

Celia Dallas, Chief Investment Strategist

Grayson Kirk and Ilona Vdovina also contributed to this publication.

Footnotes

1. A unified government occurs when one party wins the White House and both houses of Congress.
2. Please see Jan Hatzius et al., “The Effect of Tariffs on Government Revenue, Growth, and Inflation: Lessons From the Last Trade War,” Goldman Sachs Economic Research, April 6, 2024.
3. See, for instance, the Penn Wharton Budget Model which estimates that Trump’s tax and spending proposals would increase the primary deficit by $1,548 billion between 2025 and 2028, in comparison to the estimated $711 billion increase that would result from Harris’ proposals.
4. John Bistline et al., “Emissions and Energy Impacts of the Inflation Reduction Act,” Science, Vol 380, Issue 6652 (30 June 2023): 1324–1327.

The post VantagePoint: As the Narratives Turn appeared first on Cambridge Associates.

“Markets are only getting more complex and many organizations may not have the resources and scale to perform the deep due diligence that’s necessary to identify the best-in-class investments,” said Menon.

Watch the conversation here. 

Footnotes

1. A unified government occurs when one party wins the White House and both houses of Congress.
2. Please see Jan Hatzius et al., “The Effect of Tariffs on Government Revenue, Growth, and Inflation: Lessons From the Last Trade War,” Goldman Sachs Economic Research, April 6, 2024.
3. See, for instance, the Penn Wharton Budget Model which estimates that Trump’s tax and spending proposals would increase the primary deficit by $1,548 billion between 2025 and 2028, in comparison to the estimated $711 billion increase that would result from Harris’ proposals.
4. John Bistline et al., “Emissions and Energy Impacts of the Inflation Reduction Act,” Science, Vol 380, Issue 6652 (30 June 2023): 1324–1327.

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Adam Barber, Senior Investment Director in the Private Client Practice, explains how—and why—a portfolio stress test should be customized to your family’s unique situation.

View the video below. Learn more about Cambridge Associates here.

Footnotes

1. A unified government occurs when one party wins the White House and both houses of Congress.
2. Please see Jan Hatzius et al., “The Effect of Tariffs on Government Revenue, Growth, and Inflation: Lessons From the Last Trade War,” Goldman Sachs Economic Research, April 6, 2024.
3. See, for instance, the Penn Wharton Budget Model which estimates that Trump’s tax and spending proposals would increase the primary deficit by $1,548 billion between 2025 and 2028, in comparison to the estimated $711 billion increase that would result from Harris’ proposals.
4. John Bistline et al., “Emissions and Energy Impacts of the Inflation Reduction Act,” Science, Vol 380, Issue 6652 (30 June 2023): 1324–1327.

The post Video: Navigating Liquidity Challenges: The Importance of Portfolio Stress Testing appeared first on Cambridge Associates.

Listen to the full episode. 

Footnotes

1. A unified government occurs when one party wins the White House and both houses of Congress.
2. Please see Jan Hatzius et al., “The Effect of Tariffs on Government Revenue, Growth, and Inflation: Lessons From the Last Trade War,” Goldman Sachs Economic Research, April 6, 2024.
3. See, for instance, the Penn Wharton Budget Model which estimates that Trump’s tax and spending proposals would increase the primary deficit by $1,548 billion between 2025 and 2028, in comparison to the estimated $711 billion increase that would result from Harris’ proposals.
4. John Bistline et al., “Emissions and Energy Impacts of the Inflation Reduction Act,” Science, Vol 380, Issue 6652 (30 June 2023): 1324–1327.

The post Podcast: Aligning Investments with Family Objectives appeared first on Cambridge Associates.

Read the full article here.

Footnotes

1. A unified government occurs when one party wins the White House and both houses of Congress.
2. Please see Jan Hatzius et al., “The Effect of Tariffs on Government Revenue, Growth, and Inflation: Lessons From the Last Trade War,” Goldman Sachs Economic Research, April 6, 2024.
3. See, for instance, the Penn Wharton Budget Model which estimates that Trump’s tax and spending proposals would increase the primary deficit by $1,548 billion between 2025 and 2028, in comparison to the estimated $711 billion increase that would result from Harris’ proposals.
4. John Bistline et al., “Emissions and Energy Impacts of the Inflation Reduction Act,” Science, Vol 380, Issue 6652 (30 June 2023): 1324–1327.

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Ultimately, overestimating liquidity risk and the denominator effect can prevent pensions from fully optimizing their portfolio’s return potential. This paper aims to help pension executives better understand how data can enable their effective use of PI. It also discusses how new investment policy approaches may help to take advantage of market opportunities and minimize the risk of portfolio stress when down markets occur.

Following the Data

It is no secret that investing in private markets can add considerable portfolio value. Investors that have allocated to these asset classes over the long term have tended to outperform investors holding only public asset classes. And investors that managed to allocate primarily to top quartile PI managers have tended to perform even better (Figure 1).

As pensions consider PI investments, data analysis based on historical returns for private markets can help them make more informed decisions. This analysis can yield insights about how PI allocations have previously behaved across different market environments.

For example, when a crisis scenario hits, private markets are expected to react. But in reality, the severity and duration of these market reactions are not instantaneous or uniform. In crisis conditions, private market asset values and cash flow generation can decrease—but contributions can also decrease—as asset managers have fewer investment opportunities. In the years immediately following a crisis, exit opportunities present themselves and PI-buying opportunities emerge, albeit typically with lower returns than a more normal market environment.

Figure 2 compares contributions and distributions from a sample private equity fund in hypothetical base-case, crisis, and boom environments. It shows how different market situations can impact the timing of capital calls by fund managers, as well as when capital is returned to investors. Contributions are deferred in crisis scenarios as managers typically wait until opportunities present themselves, while capital is often called quickly in boom scenarios. In both environments, it is typical for most capital commitments to be called by the manager over the total investment horizon. Conversely, distribution trends track nearly parallel for all three scenarios, echoing the returns of the public market. ⁵

Putting it all together, whenever a crisis ensues, public market portfolios are immediately affected, but the value of a PI portfolio lags because valuations occur less frequently. Furthermore, private markets will call and return capital more slowly. In order to fully understand and interpret the potential impact of PI investments on pension portfolios, this complex web of inputs and outputs requires careful analysis.

Modeling an Investment Portfolio

Liquidity is a key factor for pensions investing in the private market, but at what level does the lack of liquidity cause serious risks to the pension? Figure 3 paints a broad picture of liquidity risk as a function of net distributions. In this case, net distributions is the percentage of outflows required to pay benefit payments and expenses, minus contributions.

Using this simple framework is an effective way to consider the appropriate PI allocation for a pension. However, it’s important to note that because each pension’s risk and payment profile is unique, more detailed and bespoke modeling may be necessary. This is particularly true for those that intend to invest heavily in the PI market.

Modeling can also help to inform PI allocation dynamics over time. Figure 4 demonstrates a potential PI allocation path for a sample pension. In this example, the pension has a 25% target allocation to privates, is currently paying out 5% of assets per year in benefit payments, has benefit accruals equal to 1% of pension liabilities, and is currently above PI target by 5% due to recent market movements. ⁶

Here, it makes sense to start with a micro view of the assets to ascertain expectations under base-case, boom, and crisis scenarios to inform a more refined application that allows a broader range of randomness like a Monte Carlo simulation model. ⁷ The simulation model cannot be created without the scenario modeling.

In addition to forecasting potential PI portfolio dynamics, simulation modeling analyzes the non-PI portfolio, the liability plan profile, and broader capital market forecasts. The resulting “cone of doubt” in Figure 4 is based on 5,000 return simulations, with PI values informed by the three market scenarios discussed above. As in Figure 3, models such as this can provide a view to the potential liquidity risk inherent in the pension.

In this example, the model suggests an 81% probability that, in ten years, the PI allocation percentage will be less than where it is today. Furthermore, in the few future scenarios where the portfolio exceeds 35% in privates by 2029, there is a 71% likelihood that the proportion of PI in the portfolio will then decrease. These metrics suggest that the likelihood of a liquidity crisis is low—even in a stressed market environment—as is the risk that the portfolio will be overweight PI for a prolonged period. Thus, if an investor is willing to accept an elevated allocation to privates in the near term, then a decrease in private asset commitments, or a sale of private assets at a discount in the secondary market, is unnecessary.

Reconsidering PI Ranges

It is typical for pensions to express predefined thresholds for allocations within their investment policy statement (IPS). A well-constructed IPS dictates boundaries across all asset classes and informs decision making related to trading and rebalancing. However, in the case of a PI portfolio, there are few ways to remedy an overallocation in the near term. As Figure 4 shows, even in a simulation model where the IPS boundaries are breached, an overallocation to PI is unlikely to remain above the threshold for long—and unlikely to cause a lasting liquidity crunch. These scenario projections can help bolster confidence on the part of pension executives, demonstrating that there is enough liquidity in their portfolio and that their allocation is likely to return to their IPS range over time. While the above depicts a sample case, scenario modeling such as this can be customized to specific situations.

Governance and Target Ranges

The topic of IPS ranges brings up the question of what boundaries are necessary for pensions with PI allocations. In fact, it can be optimal to create two sets of boundaries. The first is a soft guideline that, when breached, flags that the allocation is above target and action may be necessary. A second set of boundaries can be used to demarcate the point at which immediate action is warranted. When setting these two boundary ranges, it is important to note that the larger the target of the private allocation, the broader the ranges should be. For example, a 5% boundary on a 10% allocation may be reasonable but is most likely insufficient for a 25% allocation.

What If?

When pensions find themselves in the middle of a market crisis, it can be difficult to stay rooted to analysis conducted during a calmer period. However, it is at this precise moment that a pension executive’s investment decisions can lead to the largest swings in PI value. For plans looking to sell in the secondary market to lower their illiquid allocation, the lost value is clear—their holdings will sell at a deep discount, locking in losses. However, for those interested in cutting commitments to new funds, outcome analysis depicts murkier results.

For example, what if decision makers overseeing the sample pension described earlier determine that the continued risk of the private allocation increasing is too high and move to cut their next three years of commitments by half? What amount of change can they expect in asset values? These questions can be answered using further simulation modeling, but the general outcome is that the pension has more surety of the liquidity profile at the expense of lower returns.

Looking back at Figure 1, a top quartile private equity performer may outperform the US equity market by ~15% per annum and—assuming a one-time, three-year decrease in commitments—the impact to the pension is a net decrease in assets of ~2%. ⁸

Model Outcomes

Scenario modeling of PI holdings can yield a crucial takeaway for pension executives: don’t fear the denominator effect. While the magnitude of this effect is conditional on a portfolio’s broader allocation strategy, analysis suggests that, overall, it is an uncommon and typically short-lived phenomenon. Pensions with an effective investment governance framework that build a PI portfolio tailored to their investment objectives can use modeling to strengthen their conviction in the ability of optimized PI allocations to deliver stronger portfolio returns without imposing too much additional risk. Pension executives can also use scenario modeling to better assess how to balance their pension’s liquidity requirements against PI growth opportunities as they work to meet their investment objectives over time.

Jacob Goldberg, Senior Investment Director, Pension Practice

Footnotes

1. A unified government occurs when one party wins the White House and both houses of Congress.
2. Please see Jan Hatzius et al., “The Effect of Tariffs on Government Revenue, Growth, and Inflation: Lessons From the Last Trade War,” Goldman Sachs Economic Research, April 6, 2024.
3. See, for instance, the Penn Wharton Budget Model which estimates that Trump’s tax and spending proposals would increase the primary deficit by $1,548 billion between 2025 and 2028, in comparison to the estimated $711 billion increase that would result from Harris’ proposals.
4. John Bistline et al., “Emissions and Energy Impacts of the Inflation Reduction Act,” Science, Vol 380, Issue 6652 (30 June 2023): 1324–1327.
5. This is a summary of broad private equity and does not detail any other private asset classes that have a shorter or longer investment horizon. Those separate private assets have a similar contribution/distribution profile.
6. For the sample simulation, a 60/40 portfolio consisting of asset class targets 25% equities; 10% hedge funds; 40% long government/credit; 10% private equity; 10% private credit; and 5% real estate. The PI portfolio is assumed to be mature and returning 25%–30% of capital committed, while continuing commitments to target the 25% target weight.
7. A Monte Carlo simulation model seeks to predict the probability of a variety of outcomes when the potential for random variables is present.
8. It is assumed that commitments decrease by ~2.7% of total assets and that the capital is drawn over six years and returned by year 13 with a total DPI of 2.6x.

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This paper addresses this challenge. It explains the historic role that PI allocations have had in generating strong returns for large investors with longer time horizons. Next, it lays out how target date funds (TDFs), which are professionally managed pools with long time horizons, can serve as the vehicle to provide exposure to PI, while simplifying the plan participant experience. Additionally, this paper explores how to incorporate a range of PI in a TDF glide path, optimize the ability of these funds to take on illiquidity, and maximize the probability of success. Lastly, it touches on keys to successful implementation of a value-generating PI program within a TDF structure. Expanding the asset class opportunity set to include PI can provide DC plan participants with exposure to the same higher return potential seen in the broader institutional investment world, and, if implemented effectively, can result in improved retirement outcomes.

Status Report: Where Are Institutions Allocating?

The investment behavior of institutional investors over the last several decades has been meaningfully different from that of DC plan participants, where diversification away from traditional stocks and bonds has been minimal. By contrast, institutions have steadily increased allocations to alternative assets—including PI, hedge funds, infrastructure, and real assets—which now represent more than 25% of total portfolio allocations on average.

The Use of Alternatives in Institutional Portfolios: First Movers

The first movers in building more diversified portfolios were endowments and foundations, which have been significant investors in the space since the 1990s. Many endowments, as reflected in Cambridge Associates’ own client experience, have had allocations to alternatives above 20% for more than two decades and today allocate well over one-third of their assets to these investments (Figure 1).

Many defined benefit plan sponsors have taken note of strong returns among endowments and foundations and followed suit with increased exposures to alternatives. Public plans have seen the largest increase, especially over the last 15 years (Figure 2).

Corporate plans, particularly underfunded plans that are seeking growth rather than de-risking into liability-driven investment strategies, have also raised their allocations. Family offices have made significant allocations as well, currently investing an average of 43% of their total investable assets in these strategies (Figure 3).

What do these investors all have in common? The longer time horizons and institutional scale needed to reap the rewards of alternatives. While DC plans (particularly TDFs) share these characteristics, they have remained a notable outlier in their allocation decisions thus far.

Better Returns Through PI

Institutional investors have increasingly incorporated PI—along with other alternatives—in search of higher returns, and the data show that they have been successful in that endeavor. This can be seen by looking at the performance of endowed institutions with similar investment objectives. Those with high allocations to PI have outperformed those with more liquid, traditional portfolios (Figure 4).

This is especially true for those who have invested in less liquid assets, such as private equity (PE), which has generally outperformed its public counterpart over the last several decades (Figure 5).

It is also worth noting that PI offers an expanded opportunity set for investors, given that the overall number of investable opportunities in the private and public spheres are moving in different directions. Between 1996 and 2019, for instance, the total number of publicly listed US companies decreased by 47%, while the number of private equity and venture capital (PE/VC) investment opportunities grew by 85%. ⁹

Private Investing: Why?
Participant Benefits
• Higher return potential relative to public markets
• Exposure to innovative, early stage, high-potential growth companies
• Access to larger opportunity set relative to contracting public company universe
• Greater diversification

Forward-looking modeling shows the potential benefits of including alternatives in a target date glide path. An allocation of 10% to PI—divided between PE and private credit—can result in approximately 3% of additional income replacement in retirement, which is comparable to increasing a savings rate by 1%. ¹⁰

As noted earlier, the institutions that have been most able to benefit from investing in PI are professionally managed pools with a longer time horizon. The question is—how can that approach be adapted for the benefit of DC plan participants? TDFs can help bridge this gap.

The Place for PI

We believe the best place to include PI in a DC plan is through a multi–asset class portfolio, such as a TDF, which can provide the necessary professional oversight. This supervision is key, as the complexity and range of outcomes from PI make them extremely challenging for participants to manage themselves. TDFs can provide plan participants access to more sophisticated investment strategies through an easy-to-use vehicle with professional oversight. In most TDFs composed of traditional assets, a manager oversees underlying asset class exposures, asset allocation changes, and rebalancing. Enabling a professional fiduciary to oversee the inclusion of private assets in a TDF is simply a logical extension of this framework.

Incorporating PI through a multi–asset class pool also means that a participant does not need to focus on liquidity management or overall risk. Plan sponsors can take comfort that they have selected a professional portfolio management team to oversee these investment options without burdening participants with the task of conducting complex due diligence and decision making.

Range of PI Categories

Private investments are often lumped together as a single group of strategies, but their effective use in portfolios requires a more nuanced understanding. The most successful implementation approaches are those that fully recognize how different PI types can serve DC plan portfolios in different ways. Most often, certain allocations are appropriate at distinct parts of the glide path, helping to address participant needs at the appropriate time(s). Figure 6 reviews some of the major PI categories available to DC plans.

Close consideration of the roles that each of these investment categories can play in a portfolio helps to inform how to include them in the TDF glide path. Plan sponsors may be able to make the largest impact on overall performance by replacing a portion of the portfolio’s public equities with PE/VC and secondaries, and by replacing a portion of the public fixed income portfolio with private credit. While real estate and infrastructure provide some diversification, investors generally will achieve more bang for their illiquidity buck through PE and private credit. Making these changes will allow plan sponsors to better optimize the performance impact of taking on illiquidity relative to available traditional assets. The breakdown of these strategies can change across the glide path to reflect the needs of participants at each point in their lives (Figure 7).

Answering the Liquidity Question

Today, the DC system operates in a daily valued—and mostly daily traded—context, which translates into a need for robust liquidity. Assets with less than daily pricing and liquidity are already included within DC plans (for example, private companies as part of a public equity portfolio, or lower quality parts of the fixed income market). However, including a meaningful allocation to significantly less liquid assets requires careful thought and oversight to ensure that the plan is able to meet participant needs. Overall, an allocation of roughly 10% to illiquid investments balances the need to maintain plan liquidity, while still providing sufficient exposure to PI to move the needle and help accomplish participant investment goals. When thinking about liquidity, it is important to remember that the remaining 90% of the portfolio is liquid and available for cash needs.

Combined with available liquidity from the remainder of the portfolio, there is often more liquidity available from PI than is generally assumed. A mature PI portfolio is typically cash-flow positive—distributions are higher than contributions, particularly for a portfolio that includes private credit. These distributions can be used to meet participant liquidity needs or may be reinvested in the portfolio, all while maintaining sufficient total liquidity.

In addition to ensuring sufficient day-to-day liquidity, it is also important to stress test a portfolio to confirm that liquidity will remain sufficient even during down markets. The hypothetical example illustrated in Figure 8 incorporates both capital market and cash-flow stresses and provides some context for a perfect storm, adverse liquidity event.

The Name of the Game Is Implementation

Ultimately, taking advantage of the growth opportunities and diversification benefits of PI in DC plans requires negotiating two challenges: (1) building a well-designed PI portfolio and (2) situating this portfolio effectively within a TDF structure.

Manager Selection Matters

Even more so than with traditional asset classes, how private investments are implemented can spell the difference between success and mediocrity. For example, private markets can provide outsized returns, but the dispersion between the best- and worst-performing managers in PI is much larger than it is for public assets (Figure 9). In other words, while the benefits of getting private market allocations right can be far greater than with traditional asset classes, the consequences of getting them wrong can be markedly detrimental. Thus, working with an expert that has proven capabilities to conduct thorough due diligence on fund managers should be a top priority.

Performance dispersion across managers is just one of many reasons why building a properly diversified portfolio requires significant expertise. Other variables, including time (vintage year), sub-strategy (such as growth, buyouts, and venture capital), and knowledge of underlying general partners (GPs) must also be closely considered. As mentioned, secondaries can also be used to help kick-start a program. This requires proficiency in modeling private exposure(s) over time—how much capital to commit and to which managers—to properly build toward future portfolio success. As liquidity and portfolio size change, this modeling needs to be revisited—and the commitment plan adjusted—to match the evolving portfolio dynamics.

A Pooled Approach

When incorporating PI in a TDF, getting the structure right is essential, as this allows returns generated by the allocation to meaningfully benefit participants. This can be achieved most effectively by creating several pooled funds—or sleeves—for each of the major asset types: PE/VC, secondaries, and private credit. Each sleeve can include a minimal amount of liquidity for purposes of capital calls and distributions, but the primary source of liquidity is derived at the TDF level, as opposed to seeking meaningful liquidity within the private sleeves. These can invest in individual private investments, allowing for appropriate management of each underlying strategy. This structure also allows for a daily valuation process at the private sleeve level, based on the aggregate exposure to underlying managers. Each vintage of the TDF series can invest in these underlying funds, like the structure used by most TDF funds to invest in traditional asset classes. The pooling of PI into sleeves, and the accompanying pooling of cash flows, allows each TDF vintage to individually manage its exposure to each PI asset class.

Private Investing: How?
Keys to Success
• Simplified participant experience through inclusion in TDFs
• Experienced professional investment management
• Diversification across asset categories, adjusted for participant life stages
• Expert manager and fund selection
• Asset class–specific pools, with liquidity management occurring at the total TDF level

It is important to remember that private investments are less liquid than traditional stocks and bonds—each TDF vintage will not be able to precisely rebalance to a specific target the way a portfolio of more traditional assets can. The portfolio management team can accommodate by adjusting the allocations to corresponding pools of public asset classes to maintain the portfolio’s desired risk exposures. To this end, ranges around allocation targets should be designed to provide sufficient flexibility to account for the nature of PI.

Right Mix, Bright Future

A growing number of organizations are considering the use of PI in their DC plans as they strive to offer an optimized line-up of investment strategies to their employees and work to ensure a secure financial future for their plan participants. For those who opt to include them, the most successful approach will be one that is informed by both the growth opportunities and risks associated with more illiquid asset classes. DC plan sponsors should consider building out their plan’s PI allocation options via a TDF structure, using a methodology that matches the efficiency and choice available to participants in the form of more traditional assets. While this approach can result in increased investment management complexity, working with an experienced partner can help. Moreover, PI returns have historically compensated plan sponsors for the additional complications and cost. Regardless of preferred vehicle, having a clear understanding of investment strategy options and how they relate to existing traditional assets is fundamental to success. Proper portfolio implementation, including identifying and investing with top GPs, is also necessary.

Today’s DC plan participants desire—and deserve—institutional-quality investment management, including the diverse selection, robust due diligence, and potential returns that this classification implies.

Hayden Gallary, Managing Director, Pension Practice

Footnotes

1. A unified government occurs when one party wins the White House and both houses of Congress.
2. Please see Jan Hatzius et al., “The Effect of Tariffs on Government Revenue, Growth, and Inflation: Lessons From the Last Trade War,” Goldman Sachs Economic Research, April 6, 2024.
3. See, for instance, the Penn Wharton Budget Model which estimates that Trump’s tax and spending proposals would increase the primary deficit by $1,548 billion between 2025 and 2028, in comparison to the estimated $711 billion increase that would result from Harris’ proposals.
4. John Bistline et al., “Emissions and Energy Impacts of the Inflation Reduction Act,” Science, Vol 380, Issue 6652 (30 June 2023): 1324–1327.
5. This is a summary of broad private equity and does not detail any other private asset classes that have a shorter or longer investment horizon. Those separate private assets have a similar contribution/distribution profile.
6. For the sample simulation, a 60/40 portfolio consisting of asset class targets 25% equities; 10% hedge funds; 40% long government/credit; 10% private equity; 10% private credit; and 5% real estate. The PI portfolio is assumed to be mature and returning 25%–30% of capital committed, while continuing commitments to target the 25% target weight.
7. A Monte Carlo simulation model seeks to predict the probability of a variety of outcomes when the potential for random variables is present.
8. It is assumed that commitments decrease by ~2.7% of total assets and that the capital is drawn over six years and returned by year 13 with a total DPI of 2.6x.
9. This compares the decrease in publicly listed companies from 1996 to 2019 against the increase in unrealized and partially realized institutional private investments from 1996 to 2020.
10. This is based upon Cambridge Associates’ Capital Market Assumptions projected over 60 years using a Latin Hypercube model with 5,000 iterations. We modeled the same participant profile, isolating the change in investment design using 10% of total assets in PE and credit compared to public equities and bonds. For purposes of this analysis, we used a sample 35-year-old participant contributing 11% to 19% to their retirement account, 1.3% to 4.3% real salary increases, and withdrawing 70% of their pre-retirement income at age 65, while offsetting for social security. This analysis compares the assets at retirement and how long those assets last in retirement under the two investment designs.

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