Five institutional investment trends – year-end 2024

The products discussed in this podcast are only available in the United States.

MARK CINTOLO: Hello, everyone. This is Mark Cintolo from the Portfolio Analysis and Consulting team at Natixis Investment Managers Solutions. I'm joined by my colleague, Matt Hunyadi. In this episode, we'll discuss asset allocation shifts, private equity unicorns, diverging real estate returns, and more as we recap our latest institutional trends report. Matt, let's start out with an overview of the return environment as we've seen another year of really favorable returns for institutional investors.

MATTHEW HUNYADI: So institutional portfolios continued to fare well farewell through quarter 3 of 2024 despite the wall of worry around a US slowdown and growth scare, with risk assets pushing forward across asset classes. Boosted by lower yields across the board in credit, corporate pension plans led the performance pack with endowments and foundations, public pensions and Taft-Hartley pensions trailing.

Combined with a strong 2023, top corporate pension plans and public pension plans have experienced an increase to their funded status over the past two years, and even turned into a surplus for corporate pensions in 2024.

MARK CINTOLO: Yeah, funded status is assets over liabilities. So you can improve funded status one of two ways, higher assets or lower liabilities. And some corporate plans have done both. You can think about long-duration corporate bond yields as the discount rate proxy for corporates. Those moved higher in 2024.

We saw higher treasury yields that were directionally offset by cycle times and credit spreads. But it wasn't enough to keep discount rates from moving higher, particularly in December, right at the end of the year. When you have elevated discount rates alongside strong market returns, that leads to higher funded status, and has continued to support elevated risk transfer activity on the corporate side.

With public funds, it's a little bit different in that they discount their liabilities by long-term expected returns. There was a push, over a number of years, to adopt more conservative assumptions, but that's really stalled out since 2023 or so, thanks to higher yields and a strong growth backdrop.

So liabilities aren't necessarily lower, but the growth, at least, has been a bit more stable. So we've seen funded status gains on the public fund side as well, just off of lower starting levels. We're looking at funded status in the low 80s. It's not above 100, like it is on the corporate side, but still a great story considering that we were just above 65% in early 2020.

And then another bright spot has been US foundations. And they don't have liabilities like pensions, but they have enjoyed strong returns from risk assets over the last five years, like everyone else has, which has led to a meaningful increase in their capacity for grant making.

On a percentage basis, spending on grants and expenses have been pretty stable. It's looking at 7 and 1/2% to 8% of total assets every year. But that elevated asset base has meant that we've seen all-time highs for grants in dollar terms. It was estimated to be over $120 billion in 2024.

So with a backdrop of stronger investment returns and higher funded status levels, let's talk asset allocation shifts. For many of these cohorts, the mindset is not necessarily, let's earn as high of a return as possible regardless of risk, it's really more like, which asset mix will get us the best chance of earning 7%, 7.5%, with as little risk as possible? And when bonds are yielding 4% to 6%, the math moves more in your favor toward de-risking.

MATTHEW HUNYADI: So what we're looking at here is an institutional average that we created. And this is represented as a blend of corporate DBs, pension plans, Taft-Hartley, and endowments and foundations. So when we look at the data here, all plan types outside of public pensions have increased their allocation to US public fixed income since 2014 at the backs of elevated, nominal, and real yields.

For public pensions, this increase happened more recently, namely from 2022 to 2024, ended in Q3 of '24. To reduce the volatility of returns and plan assets, we'd expect that there would be some rebalancing to take place in early 2025 towards fixed income and defensive equity strategies, among a few others. While public equities have certainly gathered the flows recently, interest in private equity has triumphed across plan types over a longer-term horizon. 

MARK CINTOLO: Yeah, and it certainly seems like interest in private markets is set to continue. We looked at the Natixis Institutional Outlook piece, which surveyed 500 institutional investors. That's really a diverse mix of investors spanning pensions, sovereign wealth funds, central banks, insurance, endowments, and foundations.

And those with alternative investments were asked about their plans to increase or decrease allocations over the upcoming year. What we found was that the categories with the greatest skew toward higher planned allocations were all private markets categories-- infrastructure, private equity, private real estate, and private debt. These are the categories where respondents essentially most strongly signaled future flows were likely to happen.

Lower on the list were your more liquid alternatives, like hedge funds and managed futures. Now, this was a global survey, and the US-specific results were in a slightly different order. On the US side, it was led by private debt as opposed to infrastructure. But it was still the case that private market categories led the way. So broadly speaking, interest in alternatives appear strong. But it's more private markets and less so liquid alts.

MATTHEW HUNYADI: While longer-term private market premiums over their public counterparts remain robust, near-term performance of private market asset classes have been mixed. This is especially true in private equity. From the bottoms of the 2022 drawdown and into 2023 and '24, returns for private equity have struggled, remaining relatively flat and losing out to their public counterparts.

This contrasts with the cumulative returns seen in the Dotcom and GFC eras, where private equity was able to offer a positive skew between upside and downside capture. As the environment turns more favorable for deal-making, this could mean private equity returns could see a tailwind going into 2025.

And these returns have not only been low, but they've been tight. In addition to the return, in the context of endowments and foundations, private equity investors are experiencing their tightest return dispersion in the last five years.

A slower exit environment has meant recent returns have been more valuation-based, highlighting the need to evaluate performance via other metrics beyond internal rate of return, IRR, and your time-weighted returns for end investors.

MARK CINTOLO: And speaking of higher private equity valuations, one area of private equity that I've written and spoken about several times over the past several years is unicorns, which are privately held companies with valuations of $1 billion or higher. Of course, the joke at this point is that "unicorn" was meant to signify something mythological, or more accurately, incredibly rare. Now, we have 1,250 of them.

Unicorns are interesting to track because you get a preview of some names you might see in the IPO market over the next several years, and it increasingly shines a spotlight on how much of the opportunity set is still private. So why do we have over 1,250 unicorns when we only had a few hundred five to six years ago? Companies are certainly staying private longer. Seeing more of that growth take place on the private side.

But another part of the story, the broader equity markets performed so well over the past decade that a $1 billion valuation doesn't mean what it used to. Private equity used to be a micro-cap type of profile. But if you're at $1 billion today, that's solidly in small cap territory. So anyone on that list is at least small cap. But we have a few massive companies on the list now, too, most notably SpaceX, which, even just in December of last year, saw the valuation revised up from $200 billion to $350 billion, contributing to this recent increase in aggregate valuation that we're highlighting here.

So depending on your definition, there are 20 or even 50 companies that could be considered large cap on this unicorn list. So whether you're talking small caps, mid-caps, or even large caps, the opportunity sets increasingly a combination of both public and private.

MATTHEW HUNYADI: And after a prolonged dislocation in private equity left general partners sitting on a large pile of dry powder, it appears that 2025 could be the rebound to deal activity in both the IPO and M&A markets, which should improve exit channels and distributions across private equity. Private equity, and more broadly, other risk assets are further supported by a pro-growth administration, resilient economic growth backdrop, moderating inflation, and accommodative global central banks.

So now, flipping over to real estate, a recent run-up in public reach should give private real estate investors some excitement, right? Well, think again. Much of the returns in public rights have been driven by other sectors, like health care and data centers, which comprise lower percentages in core private real estate strategies.

MARK CINTOLO: Private real estate returns tend to lag public REITs and happen much more gradually. So two years ago, we saw private real estate lagged to the downside, with REITs falling alongside equities in 2022. But private real estate losses didn't really happen until 2023, and performance has been kind of middling since then.

But we saw really strong REIT returns in mid to late 2024, so one might think this could finally bode well for private core real estate in 2025, kind of similar to what we were just talking about with private equity. And that may be true to a certain extent. But as you mentioned, public REITs tend to be a lot more diversified than private core real estate. So some of these return drivers in the specialized categories might not be as impactful.

Core real estate strategies typically invest in four main types of properties. You have apartment, industrial, office, and retail. So some of these other sectors, like health and data centers, only make up 10% or less in aggregate. Strong returns and data centers, which has increasingly become an AI play, probably doesn't accrue to the core real estate investor to the same extent. You might need a broader real assets allocation, including something like digital infrastructure, to see those type of returns.

MATTHEW HUNYADI: And it's not all bad for private real estate, though. After two straight years of negative quarterly returns, the broad index, which comprises of your residential, retail, industrial, and office allocations, posted a positive 0.25% return in quarter 3 of 2024. And this positive return comes at the backs of 0.79% of asset depreciation as overall asset values continue to face headwinds despite the long-expected rate cuts that we saw from the Fed.

And even though core real estate is largely in those four sectors-- residential, retail, industrial, and office-- looking at their public REIT counterparts, you still saw decent returns in retail and residential in the second half of '24, and even office had a nice rebound off of pretty low levels.

MARK CINTOLO: That concludes our discussion on some of the latest trends impacting institutional investors. For more of our research and investment insights, please visit our website, im.natixis.com. And as always, feel free to reach out to us with any questions, comments, or for customized insights tailored to your specific portfolio. On behalf of the Portfolio Analysis and Consulting team at Natixis Investment Manager Solutions, thanks for your continued partnership and thanks for listening.