Private equity firms are positioning themselves as an option for financial advisors who are looking to minimize the impact of volatility on their clients’ portfolios.
A benefit to a private equity fund is that it is a long-term investment vehicle that gives an investor an extended period to invest their money and protect it from the turbulence of the markets, said Steve Brennan, head of Private Wealth Solutions at Conshohocken, Pa.-based Hamilton Lane.
These benefits often outweigh the negative aspects of private equity, such as high fees and illiquidity, proponents of such investments say.
“The time horizon for investors in the private markets is ... a much longer time period so you’re not seeing the volatility in the private markets that you would see in the public markets,” he said.
Michael Kim, president of Concord, Calif.-based AssetMark, agreed, saying a private market allocation will dampen the impact of market volatility in a portfolio.
“That’s one of the key reasons why advisors allocate a portion of their client’s portfolio to provide that stability and that dampener to volatility and some of the swings in the market that we may be seeing and that we certainly saw last year,” he said.
The timing to get into the private markets now is ideal, according to Brennan. There is also more opportunity within the private markets as the pool of public companies is dwindling.
“Being a public company is no longer viewed as the holy grail for a private company to aspire to,” Brennan said. “To get access to those companies, you need to be a participant in the private markets.”
The London-based firm PM Alpha recently released a report that advised investors to increase their allocation in private investments. It cited a lack of public companies as one of the reasons. The report stated that in the 1990s there was more than 8,000 public companies and that number dwindled to 4,266 by 2019.
That number has continued to decline as there are only 2,578 listed domestic and international companies with the NYSE and only 3,788 listed with Nasdaq as of September 2022, according to Statista Research Department.
In building a portfolio that includes private investments, PM Alpha said in its report that the 60/40 ratio is no longer effective. It called for 10% to 60% of the overall portfolio to be in private funds.
Alexis Weber, chief investment officer and founder of PM Alpha, said while that is a good range, the actual allocation should be fluid.
“When we study the best possible allocation across the last 25 years, we call it a tactical strategy allocation, meaning that every year you should have a different allocation to private markets and public markets to make sure that your portfolio as a whole has maximum returns.” he said.
Kim suggested a range of 5% to 20%, but cautioned that it depended upon the risk tolerance of the investor.
The more risk an investor is willing to take, the higher the allocation, he said. If an investor is more accustomed to public equities and the like, then Kim said they would probably be more comfortable with a smaller percentage. Regardless of the state of the economy, all investors should dedicate a certain portion of it to the private markets, Kim said.
“It’s always a great time to have allocations to these instruments,” he said. “They provide such an important part in the overall diversification. ... It gives a way for the investors and advisors to have that targeted investment approach.”
These investments also benefit the advisor who is looking to distinguish themselves among their competitors, according to Kim.
“Really having the right level of allocation to these instruments allows them to differentiate their services and their portfolio construction approach from other peers,” he said.
Private investments also allow advisors to expand their own target market to include more high-net worth and sophisticated investors, private equity advocates say. That's because they are only accessible to the accredited investor or the qualified purchaser.
There are several risks involved with private equity that advisors should discuss with their clients, Kim said. Among them is the lack of liquidity. Given the long-term nature of these investments, investors will not be able to gain access to their capital until the investment matures.
"If the clients are looking for immediate access to their funds and be able to trade out of positions, they should absolutely consult with their advisor about the liquidity for these alternative funds,” Kim said.
Private investments also have higher fees than traditional investments. These fees include performance and maintenance fees, among others. Finally, they are unregulated products. so there is a certain level of opaqueness that comes with them.
“These are not registered securities,” Kim said. “The concerns about potential fraud can lead to some regulatory issues.”
With increased interest in the private markets, firms like AssetMark and Hamilton Lane have been stepping up their efforts with advisors. Their primary work has been in education. Teaching them about private investing, how they work, and most importantly, how to use it in the context of a portfolio.
Hamilton Lane also offers an evergreen fund that allows advisors to gain access to the private markets without having to meet the same standards they would if they invested directly into them.
Whereas the normal minimums to invest can be $5 million to $10 million, evergreen funds have a much lower threshold. In addition, the accessibility is more frequent as evergreen funds are constantly open, so an investor can subscribe to a private investment either monthly or quarterly, according to Brennan.
AssetMark does not offer such options right now, but Kim said it is considering it. The firm provides other services for advisors designed to eliminate the complexities associated with private market investments.
It conducts due diligence on the investments to alleviate any concerns with the investment. AssetMark also takes steps to make the process of investing in the private markets as easy as possible, Kim said. That includes handling all the paperwork, and streamlining the process so it is no different than investing in a mutual fund.
Investments have overall slowed down because of the economy and it has had an impact on the amount of capital moving into the private markets, Brennan said. However, there are signs that will turn around as inflation is coming down and it appears that the Federal Reserve will be less agressive in raising interest rates. In this environment, Brennan sees the private markets continuing to have success.
“The market has slowed and has been in a little bit of a holding pattern for the last six months or so, but we’re optimistic about the direction that the markets are heading today from a deal flow perspective … and also from an allocation standpoint,” he said. “Financial advisors are finding the private markets attractive and allocating more of their client capital into that space.”