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With advantageous returns in global public financial markets increasingly challenging to find—owing to rising rates, concerns over recession risk, and heightened volatility— the need for differentiated sources of return has led to a spike in interest in alternative investments.
Although they provide many potential benefits, traditional private market assets have historically been challenging for individual investors to access, not only due to high investment minimums and limited access to quality managers, but also the illiquid nature of most fund formats.
Even with innovations, alternatives are best invested in for the long term by those who can bear illiquidity. Risks could arise if investors begin to see alts as a space to be traded, as opposed to compound value over time. If used successfully as part of an overall portfolio, as institutional investors have done for decades, alternatives may help individuals achieve attractive returns.
Individuals have long had difficulty accessing private equity, private credit, real estate and hedge funds. Fortunately, new opportunities are emerging for financial advisors, on behalf of their clients, to tap into these private market investments through experienced asset managers with long-term track records.
Specialization in alts funds has expanded, allowing investors to better target exposure along the risk/return spectrum to varied industries, regions and sub-strategies. Advisors are increasingly implementing these strategies as efficiency and access to asset classes continue to improve.
Private markets can also offer access to high quality innovators and value creators in secular themes— such as decarbonization— that may not be available in public markets. The number of private equity-backed companies has grown significantly, while publicly listed U.S. companies have dwindled.
Many new companies are staying private longer, often leveraging growth equity capital to expand before going public. With many industries experiencing disruption and rapid change, private companies can often be nimbler in adapting to evolving landscapes.
Yet allocating to a full desired position in an asset class may require more time to enter into new investments and could present a lack of control over when to exit, especially in times of market stress. Newer liquid and semi-liquid alternatives, which allow individual investors to access assets at regular intervals—such as monthly or quarterly—may provide more attractive benefits.
Liquid equity-oriented offerings are becoming more common. These vehicles make it easier to gain access to strategies previously available only through illiquid private funds, but they retain challenges: investment valuations for the underlying private assets may be infrequent; and share prices can deviate significantly from reported valuations, leading to a price/NAV discount.
Semi-liquid vehicles also provide liquidity only on a periodic basis and have limitations on the amount of the fund that can be redeemed. Investors might not be able to sell when they want, should other investors also elect to sell their holdings, so they should be longer-term investments.
Investors should always account for limited liquidity. It can be easy to build and rebalance alternative exposures, but it can be more difficult to convert them to cash in volatile markets.
Skill in private market investing is not evenly distributed, magnifying the consequences for investment manager selections. Dispersion in manager performance, while not a guarantee of future outcomes, can be especially clear and substantial in private equity, given its long-term, illiquid nature.
Asset managers should be able to create value in the short term and over time, in wide-ranging market conditions. They also should provide portfolio monitoring and have the resource commitments necessary to evaluate managers and their investments over time.
When necessary, portfolios should be rebalanced by modulating risk profiles but not disrupting desired balances, targeting the fullest possible exposure to private markets. Since private investment liquidity can be limited in times of market stress, investors should ensure that allocation bands provide flexibility to avoid forced actions due to short-term fluctuations.
Private market strategies can be highly varied, even significantly within the same category. This can create opportunities for diversification, but financial advisors must be able to evaluate alts funds and managers, both individually and in the context of the client’s broader portfolio.
Used correctly, private market investments can be valuable tools for building efficient long-term portfolios and accessing differentiated opportunities. Financial advisors must develop a thorough understanding of clients’ individual requirements and challenges, as well as the differences between private market and traditional liquid market exposures as they seek to build successful alternative programs.
Adam Lane is Partner, Global Head of Wealth Management Alternatives at Goldman Sachs Asset Management
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