Private markets in demand for 'risk on' EMEA institutional investors

Accelerating geopolitical risks and continued volatility in public markets are major factors driving institutional investors to increase allocation to private asset classes over the next two years, according to a study from PGIM.

Just over three quarters (76%) of respondents said they expect their risk appetite to increase over the same time period.

The survey of 250 EMEA decision makers representing $10tn of AUM showed strongest support for private credit, real estate debt and equity, and sustainable equity to meet return, income generation and risk management portfolio objectives.

Developed Asia Pacific and Emerging Europe were uncovered as top destinations for capital, whilst China and Latin America showed declining investor appetite.

Almost half of respondents (49%) expect to retain their current allocation to private credit, whilst 44% look to increase exposure to the asset class, with investors showed a clear preference for sponsored lending. While the European private credit market is less developed than the US, the region’s growth prospects look set to close this gap, providing opportunities for managers with local expertise.

Despite a challenging period for the real estate market, a recent reset in valuations is leaving investors optimistic on the asset class. Value add RE materialised as the leading area of focus across the real estate strategies, implying investors are seeking risk, but less so to the extent of pursuing opportunistic strategies.

Currently, private alternatives make up approximately 25% of survey respondent portfolios. Within this, real estate equity (18%), private credit (11%), private equity (10%) and real estate debt (10%) are the most widely held asset classes.

However, investors are most likely to increase holdings of private credit (44%), private real estate debt (42%) and sustainable equity (40%). While multiple reasons were attributed to the likely increase in private alternative allocations, global tensions and election uncertainties continue to be at the forefront of investor considerations – with 58% of survey respondents expecting geopolitical risks to increase.

In addition, 36% of survey respondents expect volatility in public markets to rise, while 42% expect volatility to remain at current elevated levels. However, while volatility in public markets is expected to move higher, almost half of the respondents (47%) expect correlations between public and private markets to decline – further supporting the case for increased portfolio weightings in alternative assets.

Thanks to healthy yields and a favourable risk profile, institutional investors are most likely to increase holdings of private credit. These investments offer higher interest rates due to the illiquidity premium, with historical gross yields in direct lending trending in the low double-digits.

In comparison, US investment grade debt yields about 5%. Family offices, private banks, foundations and endowments are most likely to boost allocations to private credit. However, a majority of respondents in the insurance and pension sectors expect to keep allocations to private credit intact over the same timeline, reflecting institution-specific constraints on holdings of the asset class.

Investors show a clear preference for private credit offerings from private equity-backed issuers. More than 90% are very likely or somewhat likely to invest in sponsored offerings, while 46% are unlikely to invest in private credit issues from unsponsored companies without private equity backing.

As for private equity, 38% earmarked this asset class for additional allocations, as evolving regulations to allow more flexibility in investing in private equity for pension funds and insurance companies are set to boost appetite for the asset class.

Geographically, institutions in the Netherlands (49%) followed by Switzerland (44%) and the Middle East (43%) are likely to increase allocations to private equity. These regions have traditionally invested less in private equity compared to peers in the UK and the US. In terms of investor channel, 58% of sovereign wealth funds expect to elevate private equity weightings, followed by foundations and endowments (43%), and pensions (42%).

Within real estate, which is transitioning from a distressed scenario to a growth environment, 42% of respondents indicated a likelihood of higher allocations to real estate debt – with sovereign wealth funds particularly likely to boost exposure. At a geographic level, investors in the United Kingdom (52%) and the Middle East (43%) are most likely to increase holdings of real estate debt. As for real estate equity, respondents were broadly divided between elevating and reducing allocations.

Impact debt and sustainable equity are no longer niche, with 40% of investors expected to increase positions. Respondents in EMEA earmarked impact investing among the top three asset classes for scaling up allocations. Sustainable equity investments recorded the most interest, with those in the UK expressing greater demand for the assets than other regions.

It is the same in sustainable debt, with UK investors particularly keen to increase allocations. Sustainable debt assets are particularly appealing to family offices, with almost half of the respondents in this segment expected to increase positions.

Finally, 37% of survey respondents expect to increase allocations to private infrastructure debt – as the low volatility in cash flows that this asset class exhibits remains a key factor for institutional investors. Middle East investors are most inclined to make allocations towards infrastructure debt, driven by the economic boom in the region and the accelerating focus on renewables and energy investments such as pipelines and liquefied natural gas. Investor enthusiasm for the private infrastructure equity space is more muted than its debt counterpart, with 28% of respondents expecting to increase positioning.