Over the last decade, private investment exploded from $4 trillion to $14 trillion. In search of differentiated returns and generation of alpha, investors, led primarily by institutional capital, poured money into private markets. This makes sense as alternative investments have consistently outperformed global public markets over 10, 15 and 20 year time horizons.
Now the investor base is expanding to include private individuals. Bain estimates that assets under management in alternative investments by individuals have risen to around $4 trillion and forecasts potential growth to $12 trillion over the next decade, representing rapid growth. Adding alternatives to portfolios requires careful consideration and we believe most people will choose to work with experienced advisors in this process.
Interested individuals should focus on three broad themes when considering alternative investing: the longer-term time horizons; Measuring investments in amounts that can be effectively set aside; and diversification, across a portfolio and within alternative shells. This applies to individuals of all wealth categories, as new mutual funds expand access for high net worth investors.
For more than 20 years, I have worked with ultra-high net worth clients whose focus is on growing and preserving their capital through investments in alternative investments. We believe that private market investing can help clients with the appropriate risk profile build a diversified portfolio. With recent product innovations, the most immediate opportunities are for higher net worth investors, but these opportunities continue to grow.
As more companies remain private for longer, a portfolio limited to listed companies will inevitably miss market opportunities. The universe of publicly traded U.S. companies has declined 43% since 1996, while the number of U.S. private equity-backed companies has increased fivefold since 2000. Less than 15% of companies with revenues over $100 million are publicly traded.
This means that individual investors have less exposure to growing companies in the broader economy by investing exclusively in public markets. We believe this trend of companies choosing to remain private is likely to continue due to greater control and flexibility, reduced regulatory reporting requirements and greater access to capital.
While private markets offer the benefits 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 requires careful selection of investment instruments and an accurate allocation size. They are also less efficient than public markets. We emphasize the importance of committing to managers who have consistent strategies and methodologies and a proven track record of outperforming public markets over time.
Our advice to clients was and is to spread their investments across a variety of alternative asset classes, managers and funds. For years we have been building alternative portfolios for ultra-high net worth clients who can tolerate illiquidity, often in the range of 20-30% of total holdings. Wealthy investors could consider half of that (10-15%) as a potential target.
We advise traditional closed-end fund clients to invest over time through consistent allocations across multiple strategies. Sizes should be similar every year. Consistency and persistence can improve diversification across vintage years.
The introduction of innovative open investment instruments has simplified the investment process for investors of all asset classes. Unlike traditional closed-ended methods of capital calls and withdrawals, these new vehicles require full capital upfront. Open-end fund minimums can be significantly lower than traditional closed-end strategies, allowing high-net-worth investors to diversify across fund categories and managers while expanding their alternative exposure.
Although they offer a degree of liquidity, individual investors must understand that these vehicles are not truly liquid. In favorable market conditions, when funds are performing well and attracting more investment, open-end products allow redemptions, usually quarterly. However, if a large number of investors wish to withdraw their investments at the same time, it is expected that full liquidity will not be available and account redemption may not be possible.
Individuals should make commitments only in amounts they can afford to commit, and treat these open-end funds as if they were traditional alternative investments – largely illiquid.
Many newer open-end funds do not yet have a significant track record because they have not yet completed full cycles, but their managers may have long track records in other structures and strategies. Investors can assess based on their resources: How strong are their teams? What are your competitive advantages?
Personal loans can be about obtaining or selecting prime loans. In other asset classes, such as private equity, top managers may be good at driving company growth organically, troubleshooting problems, and helping companies increase operational efficiency.
However, it can be difficult for an individual to assess all this. We recommend that you work with financial advisors who have access to wealth platforms with proven alternative managers. With the ability and resources to oversee multiple managers, they can help investors diversify.
Over time, more options could emerge for investors at different asset levels as retirement providers look to provide alternatives in plans that, of course, have a long time horizon. As companies remain private longer, investors look to generate alpha, and the emphasis on portfolio diversification increases, the options and access to alternative investments for individual investors are only likely to increase.