The more an advisor can understand how private funds work and where the returns come from, the more likely they are to use them in their clients’ portfolio, according to a panel of alternative investment analysts.
During a panel discussion Thursday on private markets during the “Inside Alternatives and Asset Allocation” virtual event sponsored by Financial Advisor magazine and MoneyShow, the panel discussed how advisors are comprehending the complexities of private market investing.
Patrick McGowan, head of manager research and alternative investments at Indianapolis-based Sanctuary Wealth, told the audience that while the demand is there among advisors, they have a three-prong challenge. First, they need to understand the product and the illiquidity of the funds, and they must ensure that they have the best manager.
A major turning point for advisors is their understanding of the difference in how the public and private markets are managed. Advisors were brought up with a focus on the public markets, so they do not understand how private markets operate, McGowan explained.
For instance, with regard to bank loans, when investment banks give out loans, they sell them once they syndicate them whereas a private credit manager will hold the loans along with the small returns they can yield, according to McGowan.
“In the private markets, that all goes into the investor and into the fund,” he said. “When [advisors] understand what is actually going on, where these returns are coming from and how these markets have fundamentally changed ... they almost feel as if that they should have as much as they can have allocated into this space.”
Sanctuary provides education to advisors about private funds and how they work. The firm also helps advisors determine where alternative investments should fall in a portfolio and how many illiquid assets they should hold, according to McGowan.
Once advisors have a clear understanding of alternative investments and how they work, the next step is knowing their customers, McGowan explained. That includes knowing what a client needs and their illiquidity tolerance.
Private investments, including interval funds, carry more illiquid funds than traditional equity funds. That means advisors should determine how much of a client’s assets they need easy access to. Once they make that determination, McGowan recommended moving the assets that did not have to be liquid into some type of private equity fund.
“Right now, private equity is at 12% returns which is historically like equity returns ...which is a really good place to be from the return for the unit of risk that you’re taking,” he said. “Generally, I like credit and equities to remain in the areas that they originated from—so growth or income needs.”
The private markets have been evolving over the years and the panel highlighted how the number of private companies is growing in comparison to public companies. In addition. Kunal Shah, managing director and head of private markets research at iCapital, which is based in New York, explained that the wealth management channel is an untapped market for the funds.
Advisors that comprise the wealth channel have only dedicated about 5% of their clients’ portfolios to private funds, Shah said. While a lack of understanding is hindering certain advisors from investing in private markets, accessibility is another problem, according to Shah, but that has changed.
“There has to be products and innovation for the wealth channel naturally because you can’t serve the same concept of high minimums to the private wealth channel,” he said. “What you have seen over the years is an evolution and the culmination of that evolution is applying unique technologies and workflows to allow high net worth investors to tap into high quality [private funds].”
As more advisors and investors get into the private market space, the panelists stressed the importance of the returns advisors can achieve for their clients. However, Tony Davidow, senior alternatives investment strategist at the Franklin Templeton Institute, urged advisors to be realistic when designing their investment portfolios.
"We want people to invest, but we want them to have a good experience and manage expectations,” he said.