Christopher Zook is the founder, chairman and chief investment officer of CAZ Investments. Zook has more than 30 years of experience investing in both traditional and alternative asset classes, is actively involved in public policy, and frequently serves as a resource to state and local officials.
Russ Alan Prince: How have financial advisors embraced access to private market investments?
Christopher Zook: The investment landscape is swiftly evolving, stressing the need for financial advisors to adapt to effectively serve their clients.
According to the Financial Times, the number of publicly traded U.S. companies has fallen by nearly half, to around 4,400, since the peak in 1996. That’s just 4,400 companies for investors to consider, and many of them are mediocre when it comes to profitability. In fact, back in 2009, 81% of public companies were profitable post-IPO. By the end of 2022, only 34% were profitable post-IPO.
At the other end of the spectrum, there are tens of thousands of private companies that are growing, innovating, and disrupting. In the U.S. alone, 87% of companies with over $100 million in revenue are privately held.
The growing global allocation to alternative investments, including private equity, private credit, private real estate and venture capital, presents an opportunity for financial advisors to diversify their clients' portfolios and align their investment strategies with the preferences of the world's most sophisticated investors. According to Preqin, the total allocation to alternatives is projected to see an annualized growth rate of 8% through 2028, so staying ahead of this trend is crucial for financial advisors seeking to provide their clients with access to attractive investment opportunities.
This “Great Migration” to alternatives seems unstoppable as the smart money is clearly re-allocating. How are we seeing investor appetites shifting? Put simply, it is about less public equities and more private equity. Less public credit (bonds), and more private credit. Less public REITs and more private real estate.
By providing access to private market investments, we’re seeing financial advisors offer their clients a pathway to financial success and long-term wealth accumulation in an increasingly competitive investment landscape. While public equities are vital for portfolio construction, private market investment opportunities serve as a complementary route to achieving superior returns and adeptly navigating market volatility.
Prince: How does the rising trend of alternative investment allocations impact asset managers?
Zook: Asset managers are poised to experience significant impacts from this trend. To start with, the democratization of alternatives is forecasted to result in trillions of dollars flowing into established asset managers.
This influx of new capital presents a substantial opportunity for asset managers to expand their portfolios and grow their businesses. In particular, the rise in individual investor interest in alternative investments means asset managers can expect increased demand for their services and expertise in managing these asset classes.
Moreover, as individual investors allocate more of their portfolios to alternatives, asset managers will likely experience a surge in the assets they manage, which is exceedingly valuable to their business. Overall, the increasing allocations to alternative investments by individual investors represent a significant tailwind for asset managers, driving growth opportunities and the potential for significantly increased profits for the owners of those businesses.
Prince: What sets General Partner Stake investments apart from traditional private equity or private credit funds?
Zook: GP stake investments allow an investor to own a portion of the asset managers who are benefitting from the growth of the private markets. Mechanically, a GP Stake involves acquiring minority ownership in the asset management business. Put simply, a GP Stake involves the purchase of a minority and passive interest in a private equity or private credit firm, allowing investors to sit shoulder-to-shoulder with the owners and benefit from the long-term success, growth, and profitability of the asset management firm itself.
These investments stand out from other private equity strategies due to their substantial yield components, diversified downside protection, and advantages derived from the success of the underlying firms.
A major benefit for GP Stake investors is the opportunity to participate directly in the private asset management firms' revenue engines, benefiting from management and performance fees, which typically lead to very high profit margins. These businesses are typically highly efficient and benefit directly from economies of scale, often generating north of 60% gross profit margins. These investments also offer immediate cash flow and the potential for that income to grow, as well as to benefit from the growth in the value of the business itself.
The fuel for the growth of the asset class is generated by significant historical outperformance compared to public equities. For over three decades, between 1986 and mid-2023 (6/30/23), U.S. private equity as an asset class produced average annual returns of 14.3%, while the S&P 500 produced 9.5% percent. That’s nearly 50% greater compounded annualized returns.
GP Stake ownership also provides built-in diversification across various market cycles, industries, sectors, and geographies. Since private asset management firms manage multiple funds spread across diverse investments, GP Stake investors benefit from exposure to a broad range of opportunities, providing downside protection and potential upside.
One of the most common questions is why successful private asset managers would consider selling a GP Stake. With the growing practice of firms committing significant personal capital to their own funds, known as GP commitments, they face cash-intensive requirements. Selling a minority interest GP Stake provides firms with much-needed capital to meet these commitments and fuel growth. This capital infusion is typically directed towards funding GP commitments into new funds, thereby accelerating enterprise value growth. Secondary reasons for selling a GP Stake may include succession planning, strategy extension, or geographic expansion.
Ultimately, investors in GP Stakes have several options to realize returns on their investment. While GP Stakes are generally considered illiquid, there are avenues for generating liquidity. These include periodic tender offers from GP Stake funds, selling positions in secondary transactions, acquisition by other industry players, or the firm going public. These options offer investors opportunities to exit their investments and realize returns beyond the income stream provided by GP Stake investments.
Russ Alan Prince is a strategist for family offices and the ultra-wealthy. He has co-authored 70 books in the field, including Making Smart Decisions: How Ultra-Wealthy Families Get Superior Wealth Planning Results.