Most investors in mainstream exchange traded funds will have enjoyed a lucrative year, even as BlackRock, the largest ETF provider, has made significant forays into unlisted private assets.
The $656bn SPDR S&P 500 ETF Trust (SPY), the largest ETF of them all, has delivered punchy returns of 25 per cent over the past year, although the largest fixed income ETFs have essentially trod water over the past 12 months.
However, US equity valuations now look very rich by historical standards, at an unusually high 23 times forward earnings. And if US stocks are looking toppy, this would not just be a problem for those investing exclusively in Wall Street: US equities now account for 70 per cent of the market capitalisation of global developed market stocks in MSCI’s widely followed World benchmark, compared with 30 per cent in the 1980s.
These factors have prompted a debate among analysts and other industry figures as to whether investors should move beyond the traditional 60:40 portfolio of 60 per cent publicly listed equities and 40 per cent publicly listed bonds.
The BlackRock Investment Institute, an internal think-tank hosted by the world’s largest asset manager, argued in its annual global outlook report released in December that we are at the beginning of a major transformation in which “mega forces” such as artificial intelligence and the transition to a low-carbon economy are creating a new industrial revolution that will instead require investment in private, unlisted assets.
“We think investors should broaden out where they invest. That may include private markets, notably private credit and infrastructure,” the authors of the report say.
The new normal calls for a more “tactical” and “thematic” approach, they argue.
BlackRock has been putting its own money where its mouth is.
Earlier in December BlackRock agreed to pay more than $12bn to acquire private credit manager HPS Investment Partners, and in October it completed the $12.5bn purchase of infrastructure investment firm Global Infrastructure Partners (GIP). BlackRock has also agreed a deal to purchase Preqin, a UK private markets data group, for £2.55bn.
It has also recently announced the launch of a suite of private markets funds aimed at wealthy European clients.
Retail investors have had fewer opportunities than their wealthier or institutional counterparts to access private markets, which typically require investors to commit to long-term investments that might be hard to exit.
Retail opportunities in private assets have until recently also found it hard to gain traction. A report to the European parliament in September found that at the last count in 2021 only 57 funds using the European Long-Term Investment Fund (Eltif) structure, which is open to retail investors, had been launched since the framework was established in 2015, with total assets of only €2.4bn.
However, evidence shows managers are seeking to ramp up retail participation in private credit, in particular.
Kenneth Lamont, principal at Morningstar, said the research and data provider had evidence of more launches of Eltifs and Long-Term Asset Funds (Ltafs), the UK equivalent, over the past year than in any year since 2015.
“The performance of some private assets has been good. My real issue is: is it even useful or desirable for investors?” Lamont said.
He believed the idea that retail access to private assets should be expanded needed scrutiny. “Can you provide safe, liquid access? Are you hiding the risk somewhere else in the structure?” he asked.
Lamont said the push towards a public/private market convergence was something investors should remain wary about and pointed to the growing availability of collateralised loan obligation ETFs, which package up loans made to companies by banks.
“Which retail investor needs a basket of CLOs?” Lamont said.
Currently only one CLO ETF is available in Europe, the Fair Oaks AAA CLO ETF. But already the US has around a dozen CLO ETF offerings. Most are dwarfed by Janus Henderson’s AAA CLO ETF (JAAA) which has $16.5bn in assets under management. The next largest, also from Janus Henderson, the B-BBB CLO ETF (JBBB) has $1.4bn.
However, MJ Lytle, chief executive of Tabula Investment Management, an arm of Janus Henderson, fiercely defended the concept of a CLO ETF, arguing that CLOs should not even come within the definition of private assets.
Lytle said that while the individual loans in the CLO could be seen as a form of private credit, investors were in reality “a couple of layers away from that” and there was high turnover in the CLO market, which meant that CLOs, unlike private markets, offered liquidity.
“The idea of an ETF is the manager can change the number of units outstanding to balance supply and demand. The only way you can do this is to build it out of liquid assets. If this does not happen, there will be discounts and premiums to the net asset value,” he argued.
He said that it would be fairer to compare the underlying exposure within CLO to high-yield bonds, pointing out that the two assets had considerable overlap, with many companies relying on loans as well as bonds to fund their businesses. However, the AAA tranche of CLO transactions is comparable to high-quality investment grade bonds, both in credit risk and liquidity, he said.
In the meantime, Lamont argued that if private assets become more available to retail investors, greater participation might erode the potential future gains.
“As private assets become more accessible, the market for them is likely to become more efficient, with fewer mispriced assets and less profit opportunities,” he said.
“Exactly how providers offer liquid exposure to illiquid assets will remain the key point of focus as options grow,” he added.
