Amid a challenging macroeconomic environment, investors are shifting their portfolio allocations from public to private assets, and this trend is expected to intensify further in the coming years, a new study finds.

Over a third of institutional investors (36%) have already allocated more than 50% of their portfolio to private markets, and this is set to grow to 41% of institutions doing so over the next three to five years, according to State Street Corporation’s third annual private markets survey. Over half of institutions (59%) have already allocated 30% or more to private markets, and this is expected to grow to 71% by 2028.

The survey commissioned by State Street and conducted by CoreData Research, covered 480 respondents from traditional asset managers, private market managers, insurance companies and asset owners across four regions, North America, Latin America, Europe and Asia-Pacific. It was conducted from September to November 2023.

Infrastructure and private debt are the most attractive asset classes, with 71% of respondents expecting to increase allocations to both over the next one to two years. However, longer-term private equity is set to return to favour, with 73% of investors planning to increase allocations to the asset over the next three to five years. Investors intend to decrease allocations in public markets to meet increased demand for private exposure.

“The great rotation from public to private markets is not slowing down, with investors set to allocate more to private assets than ever before,” says Donna Milrod, executive vice-president and chief product officer at State Street. “This increasingly sophisticated private market universe means the current economic environment, coupled with investors’ desire for wider, more diverse avenues of capital, is making private markets attractive now and for the foreseeable future.”

Macro challenges

Challenging market conditions are expected to remain in the near term. The majority of respondents (61%) believe that inflation has peaked in their local markets, but most do not believe it will fall back within their local central banks’ target range over the next two years.

For most respondents (58%), macro challenges are making fund raising difficult, which is leading to delays of three months to a year or more. In response, they are increasing their diversification, investment in risk management, and reducing risk exposure with 43% exploring fresh market niches, 38% enhancing risk management processes, and 34% reducing risk to protect against downside.

“Overall, while demand for private market assets continues to grow, investors are also experiencing a tightening supply of quality deals and express that borrowing costs can be an issue for them,” says Scott Carpenter, global head of private markets and credit at State Street. “Central bank decisions on rates and the state of inflation will heavily influence opportunities and investing behaviours over the next couple of years."

High hopes for AI

Institutions have identified risk measurement and management, liquidity management, and the ability to forecast future and capital pacing as among the top operational challenges they face when investing in private markets. Almost 80% of investors are looking for a centralized, accessible platform for public and private asset data, as the current lack of availability, accuracy, and timeliness of data is an overlooked aspect of private markets, according to the survey.

 However, recent advancements in artificial intelligence have the potential to improve private markets operations significantly. Nearly half of respondents (43%) believe that machine learning has the potential to enhance private markets operations, while more than half (58%) believe that generative AI will enhance operations.

“AI excitement from institutional investors is driven by the industry’s historic deficiencies in quality private market data,” Milrod notes. “Subpar access to quality data is a major impediment that stands in the way of a firm’s ability to view and assess public and private assets data in one place. As we speak with clients, it is clear AI has the potential to hugely improve this aspect of the market.”

Meanwhile, institutions remain sceptical about prospects for increased retail investment in private markets, but see potential for legislation to open options and drive flows. More than half of respondents (54%) believe current investment products do not make the asset classes suitable for retail investors, while around half (49%) believe there is strong demand for access to private markets among retail or defined-contribution investors.