Superannuation funds should make a meaningful allocation to private capital to reap the rewards of a sophisticated private capital strategy, according to Mercer partner Ray King.
King said that institutional investors had allocated quite a bit of money to private capital up until 2008, when the trend changed and allocations shrank.
But opportunities abounded in market inefficiencies between private capital's sub-asset classes, he said.
Mercer recommended a private capital allocation of 25 per cent concentrated in four sub-asset classes, King said.
"Each of those sub-classes has their own fairly dynamic performance drivers and as a result they tend not to move in tandem from a performance perspective.
"What we get is they're relatively inefficient markets, so that also creates opportunity between the different sub-classes and we get significant differences in relative performance."
King said it was likely super funds took a negative or conservative view on private capital.
"If they think they're probably going to get 7 per cent from traditional asset classes – we would argue that if they implement a very good program using private capital, they can achieve double that return," he said.
Listed markets were hard to predict, and when predictions were made it often resulted in only a small reallocation, he said, citing listed REITs as an example.
"They may have decided to add 1 per cent to their allocation, and over the last year we've had that return around 30 per cent.
"What they tend to do is tilt a portfolio, take very slight positions, and I think what we're recommending is that in a good private capital program you take much more substantial, very significant overweight positions," he said.
Private capital returns were easier to predict if the groundwork had been laid, King said, but super funds were concerned with fund manager fee ratios.
Funds were also used to more static asset allocation strategies, King said, and coupling this with past poor performance during the GFC, institutions were under-estimating the performance a meaningful private capital allocation could deliver.
