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In the past decade, private investments exploded from $4 trillion to $14 trillion. Primarily led by institutional capital, investors poured money into private markets in their search for differentiated returns and alpha generation. This makes sense as alternative investments have consistently outperformed global public markets on 10-, 15-, and 20-year time horizons.
Now, the investor base is expanding to individuals. Bain estimates that assets under management in alternatives from individuals has risen to around $4 trillion and projects potential growth to $12 trillion in the next decade, a rapid expansion. Adding alternatives to portfolios requires careful consideration and we believe most individuals will opt to work with experienced advisors in that process.
Interested individuals should focus on three big themes in alternatives investing: the longer-term time horizons; sizing investments in amounts that effectively can be put aside; and diversification, across a portfolio and within alternative sleeves. This applies to individuals across wealth categories as new open-end funds expand access for high-net-worth investors.
For more than 20 years, I have been working with ultra-high-net-worth clients focused on growing and preserving their capital by investing in alternatives. We believe private market investments can help clients with the appropriate risk profile build a diversified portfolio. With recent product innovations, the most immediate opportunities will be for investors at higher wealth levels, but those opportunities continue to expand.
As more companies stay private for longer, a portfolio limited to public companies inevitably will miss market opportunities. The universe of U.S. public companies has declined 43% since 1996, while the number of US private equity (PE) backed companies has increased five-fold since 2000. Fewer than 15% of companies with revenues over $100 million are public.
This means individual investors have narrower exposure to growing businesses in the broad economy by investing solely in public markets. We believe this trend of companies choosing to stay private is expected to continue, owing to greater control and flexibility, lower regulatory reporting requirements, and better access to capital.
While private markets offer advantages of broader economic exposure, diversification and alpha generation, it is important to understand their differences from public markets.
Private markets require longer-term capital commitments. This necessitates careful selection of investment vehicles and precise allocation sizing. They are also less efficient than public markets. We stress the value of committing to managers who maintain consistent strategies and methodologies, and who have proven track records of outperforming public markets over time.
Our advice to clients has been, and remains to be, to spread their investments across a variety of alternative asset classes, managers, and funds. For years we have built alternative portfolios for ultra-high net worth clients who can tolerate illiquidity, often in the 20-30% range of overall holdings. High-net-worth investors might look at half of that (10-15%) as a potential target.
We advise clients in traditional closed-end funds to invest through consistent allocations across multiple strategies over time. Sizes should be similar each year. Being consistent and persistent can enhance diversification over “vintage years.”
The introduction of innovative open-end investment vehicles has simplified the investment process for investors across wealth brackets. Unlike traditional closed-end methods involving capital calls and drawdowns, these new vehicles require full capital upfront. Minimums in open-end funds can be significantly lower than traditional closed-end strategies, allowing high-net-worth investors to diversify across fund categories and managers as they grow their alternative exposure.
While they offer a degree of liquidity, individual investors must understand that these vehicles are not truly liquid. In favorable market conditions, when the funds are performing well and attracting more investments, open-end products will allow redemptions, usually on a quarterly basis. However, when a large number of investors wish to withdraw their investments simultaneously, it should be assumed that full liquidity will not be available and account redemption may not be possible.
Individuals should only make commitments in amounts they can afford to have tied up and treat these open-end funds as if they were conventional alternative investments – largely illiquid.
Many newer open-end funds do not yet have significant performance track records, not having been through full cycles, but their managers can have long track records in other structures and strategies. Investors can judge by their resources: how strong are their teams? What are their competitive advantages?
In private credit, it may be sourcing or top-quality credit selection. In other asset classes, such as private equity, top managers may be good at driving company growth organically, fixing problems, and helping companies create operational efficiencies.
Yet it can be hard for individuals to judge all of this. We suggest they work with financial advisors who have access to wealth platforms with proven alternatives managers. With the ability and resources to monitor multiple managers, they can help investors with diversification.
Over time, more opportunities for investors at different wealth levels could increase as retirement providers look to make alternatives available in plans that naturally have long time horizons. As companies stay private for longer, investors seek alpha generation, and the emphasis on portfolio diversification grows, opportunities and access to alternative investments should only continue to expand for individual investors.