The challenge

How can I reduce the effect of the J-curve of alternative investments in my portfolio?

Investments in private markets are becoming becoming an increasingly core component of asset allocations for investors. At the same time, pension funds and insurers need to balance the desire to harvest illiquidity premia with the need to retain sufficient liquidity to meet their liabilities.

The action

As pensions look to increase their exposure to illiquid alternatives within their return portfolios, long ramp-up periods can result in investment outcomes being impacted as a result of waiting solely in cash.

In many instances, we find that clients underutilise risk budgets as a result of this overallocation to cash, whilst awaiting capital commitments.

In this instance, BlackRock was able to create a liquid market complement to the private market portfolio, which allowed the client to be fully invested from year 0 to avoid double and reduce cash drag and mitigate J-curve effect.

BlackRock leveraged our risk management platform, Aladdin, to identify private market macro exposures that could be accessed through iShares ETFs such as economic growth, real rates, credit, inflation and emerging markets.

BlackRock created customised baskets of ETFs replicating the macro.

The Curse of the J-Curve

The Curse of the J-Curve

Source: BlackRock, as at May 2020.
For illustrative purposes only.

Private Market Basket

Private Market Basket

Source: BlackRock, as at May 2020.
For illustrative purposes only.

The outcome

While risk-return profiles and the idiosyncratic nature of private markets differ from public markets, macroeconomic and style exposures driving these investments may be more similar.

In this instance, the active risk of the ETF baskets demonstrated that the macro exposures in private markets could be replicated to high quality and therefore acted as a good interim vehicle for their private market investments.

Why indexing?

While alternative investments have idiosyncratic risks that cannot be replicated through indexing, certain macro risks such as economic growth or real rates can. Such indexed strategies can offer alternative-like exposure on a temporary basis. The liquidity of the ETF market also made ETFs valuable as tactical investments solutions to help manage cash flows in a more targeted manner while reducing the risk of a funding shortfall.

Case studies are for illustrative purposes only; they are not meant as a guarantee of any future results or experience, and should not be interpreted as advice or a recommendation.


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