In a note to clients published Monday, UBS strategists discussed vintage diversification, a strategy that involves spreading investments across different periods to navigate economic cycles and mitigate return volatility.
By adhering to a structured investment plan, investors can harness the potential of vintage diversification, thereby achieving robust, self-funding portfolios, UBS notes.
To be more specific, vintage diversification refers to allocating capital across different investment years or "vintages." This approach helps investors manage the impact of varying economic conditions on their investments, as private market assets are typically held for several years and are influenced by their acquisition year.
UBS highlights that predicting which vintage will perform best is complex, but consistent annual commitments can smooth out performance across economic cycles.
The bank outlines four key strategies for achieving systematic vintage diversification:
1) ‘Design and Stick to a Commitment Roadmap:’ According to UBS strategists, investors with substantial resources should create a detailed annual commitment roadmap. This involves planning out capital allocations over successive years and ensuring adherence through proper governance mechanisms.
2) ‘Invest in Successive Vintage Programs:’ Allocating capital to successive vintage programs or fund structures that invest in multiple primary funds within a single year is another effective strategy, UBS points out.
This approach automatically diversifies an investor’s portfolio across different vintages, managers, and sectors, often at lower investment minimums.
“Investors may also choose to allocate to multi-vintage programs, which invest over a pre-defined number of years (typically two or three),” strategists wrote.
“With such an approach, investors no longer need to commit every year, but instead adjust their commitment cadence to that of the multi-vintage program,” they added.
3) ‘Invest in Secondary Funds:’ Secondary funds provide another pathway to vintage diversification. These funds involve buying stakes in existing private market funds, typically at a discount.
UBS notes that secondary funds offer accelerated exposure build-up, reduced blind-pool risk, and a mitigated net cash flow curve, as they invest in funds that have already begun their investment process. Although returns might be lower compared to other private equity strategies, secondary funds provide a diversified portfolio of investments across several years.
4) ‘Invest in Perpetual Funds:’ Perpetual funds, which do not have a finite life, offer continuous vintage diversification, strategists highlight.
Unlike traditional closed-ended funds, perpetual funds reinvest proceeds into new opportunities, maintaining a steady portfolio composition.
“Investors get into a perpetual fund at the latest NAV, allowing them to build their exposure from day one,” UBS explains.
“Effectively, they buy a “slice” of the perpetual fund’s portfolio upon commitment, which is already diversified across vintages as the fund has been active for several years.”
This method allows for sustained vintage diversification as long as the investor remains in the fund.