With stocks in bear market territory, bonds at double-digit declines, and high inflation eating away at principal parked in cash, many financial advisors are employing tactical rebalancing to protect client portfolios from the recession we foresee in the next 12-18 months. Advisors are selling sectors that have relatively done well in the past 12 months — energy and commodities — and purchased a much beaten-down, but higher-yielding bond market — as evidenced by positive flows into their treasury bond, corporate bond, and high yield bond ETFs.
As investors see the benefit of tactical rebalancing in public market funds, and as allocations to private capital grow across the high net worth channel, they may wonder if this type of strategy is available for private capital. It is important to remember that private capital is fundamentally different than public market funds — with commitments ranging from 5 – 15 years in length, sometimes lasting through 1 or 2 full business cycles, private capital funds cannot be manipulated as easily as public market funds. Because there is very little to be done once allocations are made, advisors and investors must adopt a different strategy for recommending allocations to private capital.
At Balentine, we’ve identified three key considerations for selecting long-term investment portfolios in private capital as part of our unemotional, data-driven investment process:
1- Diversify Tactically
Regardless of risk profile, we recommend investors allocate to the following asset classes:
- Private equity. As the highest risk and return asset class in private capital, we recommend multiple commitments across early stage, growth stage, and mature companies. We accomplish this through a core holding in Adams Street, which diversifies one investment across all stages of companies, lowering the impact of one company failing.
- Real Estate & Infrastructure. These sectors tend to have inflation-linked cash flows, providing additional diversification in inflationary times. For example, 70% of the assets in our Pantheon Infrastructure fund have cash flows that link directly to Consumer Price Index (CPI).
- Private debt. In a time when multiples are resetting and interest rates are rising, private debt could provide meaningful diversification via a floating 7% - 8% yield in a first lien security. For example, we recommend even our most aggressive private capital portfolios incorporate secured debt with our partner Monroe.
2- Vet Managers Rigorously
Fund managers provide private capital opportunities, and our clients trust us to recommend fund managers with favorable terms, fees, and opportunities. To this end, we employ a disciplined and demanding underwriting process. A few of the criteria we analyze are listed below:
- Experience Managing Through Recessions. We find that private capital firms that have experienced recessions have codified lessons from these times into their culture and approach. For example, among our partners, Adams Street, Pantheon, Harbert, and J.F. Lehman began investing well before the dot.com craze in the late 1990s; and Fulcrum, Monroe, and Panoramic began investing in the early to mid-2000s.
- Demonstrate Discipline. We look for firms that are disciplined when the world around them loses its discipline. This quality becomes invaluable during times of stress — when tough decisions must be made around capital rationing and pivoting business plans.
- Think Ahead. In less-than-ideal circumstances, we feel that success follows managers that focus on maximizing opportunities rather than recouping losses. For example, our partner Peachtree Hotel Group, with experience managing through the global financial crisis in 2008/09, moved quickly during COVID-19 to launch, fundraise, and deploy hundreds of millions of dollars into distressed hotel loans that banks were anxious to get off their books.
- Minimize Use of Leverage. We also look for managers that drive value through operational expertise rather than rely on high use of leverage — something gained through decades of investing experience. This is a core fundamental of our partners Pantheon and J.F. Lehman.
3- Adhere to Themes
The last thing we look to do when constructing private portfolios is lean into managers or themes that can do well even when the broader market struggles. We identify themes through observation of the world around us and confirm them through data analysis.
- Long-Term (Intergenerational) Themes capture seismic movements in the market, and they have a higher likelihood of being decoupled from the overall market as the size and attractiveness of the opportunity can overcome market weakness. For example, we are putting money to work in one of these themes with multiple investments in managers focused on decarbonizing our energy stack. We see this as a $50 trillion+ opportunity over the next 30 years that could be rewarding for investors who allocate money to it. Other themes that drive our investment include: the changing landscape of healthcare and biotechnology, artificial intelligence and robotics, and persistent growth in the Sunbelt region. These themes, coupled with our rigorous manager due diligence, should provide fruitful investments for our clients in the coming decade.
- Medium-Term themes capture opportunities that should play out over the life of the fund versus over multiple decades. For example, J.F. Lehman is a leveraged buyout manager focusing on investments in defense, aerospace, and environmental service companies — companies that typically rely more on regulated services and defense spending than consumer and corporate behaviors. This approach can cause their funds to lag their peers in times like 2010 – 2020 as the prices paid for software-as-a-service and technology companies reached nose-bleed levels. However, investing in them during a recessionary period pays dividends as discretionary spending dries up.
When it comes to private capital, we at Balentine do not wait until the moment of crisis to do what we can with what we have. We acknowledge that the hard work needs to be done much before the onset of the crisis. We believe our discipline of diversification, rigorous manager selection, and thoughtful portfolio construction can provide a level of insulation regardless of market activity.
 Balentine, Markets Anticipate a Cleansing for the Post-Pandemic Economy