Hamilton Lane and other firms that focus on private markets have a “target-rich environment,” says Brennan. He notes that there are 17,000 privately held companies in the United States with at least $100 million in revenue, compared to around 2,600 publicly traded firms.
Firms with a long history in sourcing alternative investments bring a wealth of insights that small advisory teams simply can’t muster. “We look at 1,500 investments per year,” says Christopher Zook, founder and chief investment officer of Houston-based CAZ Investments. The overwhelming majority of those scoured investments will receive a hard pass. Investments under scrutiny include private credit, real estate, venture capital, and other assets that are not strongly correlated with equity markets.
CAZ’s sweet spot is a hybrid approach toward client access. CAZ provides access to unique alternatives and partners with external advisors, allowing those advisors and their clients to invest alongside CAZ. Like iCapital, this approach enables CAZ to boost its collective buying power, “allowing it to access more proprietary investments, often at preferred terms, for everyone involved,” Zook noted.
Zook adds that his firm is in the process of developing a new fund geared towards risk mitigation, the specifics of which can’t yet be publicly disclosed due to SEC regulations. As Howard Marks has observed, risk mitigation could prove to be a savvy survival strategy in the period ahead. “Portfolios need insurance too,” Zook says.
Private debt funds have become increasingly popular over the past decade. Through the 10 years ended September 2020 (the most recent data available), private credit assets under management worldwide have almost tripled from $341 billion in 2011 to $975 billion, according to Preqin.
Private credit has steadily grown in popularity due to low interest rates and reforms resulting from the 2008 economic crisis. At that time, many banks moved to sharply reduce their exposure to direct lending in order to pass stress tests.
To fill the void, private lenders stepped in to provide short-to-medium term loans to condo developers, warehouse builders and other large real estate projects. Private debt funds have typically delivered 5% to 10% annual returns, typically yielding several percentage points more than public debt funds. Funds that deploy leverage have been able to deliver the strongest yields.
In a 2020 survey of expected returns for the decade ahead, with respondents including Vanguard, Goldman Sachs, J.P. Morgan, BlackRock and others, Horizon Actuarial Services found that private debt should be expected to generate a 7.75% annualized return over the next 10 years, compared to 2.70% for U.S. corporate bonds.
So far, those returns have historically been comparatively modest. Private debt lenders often require at least 60% equity in a project. If the project runs into trouble, the lenders can simply take ownership and unload the assets for at least the size of the loan.
Michelle Connell, a CFA who runs Dallas-based Portia Capital Management, has made extensive use of the relatively high yields offered by private credit funds. She counts a number of non-profit foundations among her clients.
“I can’t afford to see them lose any money on their investments,” Connell says. She has also been able to garner double-digit yields through investments in real estate-focused private credit funds, though she concedes that as more funds flow into that category, yields have begun to fall from the double-digit range.