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December 5, 2024
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Private Equity

Clients want in on private markets. Should advisors hold their hands?


Despite recent attempts to democratize private equity, private credit and other sorts of nonpublic markets, they remain treacherous territory for ordinary investors.

If everyday workers and savers decide to start putting money into these often opaque vehicles — and there are plenty who say they shouldn’t — many are likely to turn to advisors for help. Jay Sammons, a portfolio manager for private markets at Atlanta-based Gratus Capital, said he thinks offering access to nonpublicly traded investments is quickly becoming “table stakes” for larger advisory firms, meaning it’s something that their clients have grown to expect.

That gives advisors a rare opening to establish their expertise in finding the best opportunities in a field that’s littered with high fees, opaque investing strategies and barriers to pulling money out. Sammons said it can be difficult for regular investors to know what questions to ask when trying to select an investment, given the great variety of private products now on offer.

“So for instance, there may be one or two home runs among four or five funds in a portfolio, and that might have worked out to a decent [internal rate of return],” he said. “But it’s also about understanding how they’re generating those returns, what their strategy is and how well they stick to that strategy in practice.”

Fee for all

Private markets have plenty of detractors. For many, their worst drawback is high fees. 

A research paper published in August 2022 by The Ohio State University’s Fisher College of Business found that private equity funds that specialize in buying out companies tend to see their net returns reduced by 6 percentage points annually. The culprits, according to the study authors, are usually management fees and interest costs.

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Recent innovations in the public markets — particularly commission-free stock trading — have helped make such fees look particularly unattractive. Investors can now buy an exchange-traded fund like the iShares Core S&P 500 ETF and gain broad exposure to the shares making up one of the most commonly cited market benchmarks at an annual cost of 0.03% of their total investment. The fund, traded under the symbol IVV, has returned more than 26% in the past year.

Of course, this past year’s bull run in the stock market has not been typical. The iShares Core S&P 500 ETF’s average annual return since its inception in 2000 has run around 7%.

Wealth managers who’ve been good pickers of private investments have been able to do better. Largely for that reason, private markets have gained in popularity among registered investment advisors and other financial planners. 

A report in September from the research firm Cerulli found that just over 80% of the 200 firms surveyed said they think their private offerings help set them apart from rivals. And nearly seven out of 10 said providing access to private markets aided in attracting high net worth clients.

Hedge against downturns

Sammons said one of the advantages of private markets is that they provide solid ballast in years when public markets are down. Detractors often criticize private equity, private credit and similar vehicles for their illiquidity, or the limits they place on investors’ ability to pull their money out.

But these restrictions can be an advantage at times when worsening economic conditions stoke an urge to yank investments out of stock and bond markets.

“You don’t have the sometimes sporadic market swings where you’re pricing in good or bad information into the public markets immediately,” Sammons said. “You’re not going to have that type of push and pull on good or bad news in the private markets. So you’re clearly not going to have the volatility.”

To achieve the stability offered by private markets, investors need to be able to lock their money up for relatively long periods. That’s why private vehicles are often reserved for wealthy investors. Sammons said Gratus Capital, which reported $2.1 billion in assets under management on its latest Form ADV, generally works with clients with $500,000 or more to invest.

Federal law often prohibits people from investing in private markets unless they first qualify as “accredited investors.” These are usually people with $1 million or more of net worth (not counting their primary residence) or $200,000 in annual income in the past two years ($300,000 if they file their income taxes jointly).

Growing private markets, shrinking public

Despite the drawbacks of private markets, many advisors see them as a land of opportunity. 

The consulting giant McKinsey pegged the total amount of private assets under management at $13.1 trillion by the end of June last year. Even though McKinsey found that private fundraising slowed by 22% in 2023, vehicles of this sort still managed to bring in $1 trillion globally last year.

The amount of money in public markets far exceeds that. Still, though, tradable stocks are becoming rarer commodities.

The Ohio State University’s report on buyout firms noted that the number of public companies in the U.S. decreased by half from 7,509 in 1997 to 3,530 by the end of 2020. A recent lack of companies selling stock for the first time through initial public offerings has contributed to this dearth and sent investors looking for opportunity elsewhere.

So a movement is afoot to further open private markets to everyday investors. Some advisors say that’s not necessarily a bad thing, as long as precautions are taken.

Aaron White, the chief growth officer and principal at the advisory firm Adero Partners in Pleasanton, California, said the recent lack of IPOs means investors who want to bet capital on startups. White said his firm’s clients typically have $2 million to invest and can thus afford some risks.

“So we’re looking at investing earlier on in private equity, to try to capture some of that growth,” he said.

White said it’s generally accepted that private equity, credit and real estate can offer higher payouts than public investments. What’s not as well understood, he said, is that the returns can vary greatly from one opportunity to another.

A certain amount of expertise, he said, is needed to find the good bets.

“And if you can get access to the best managers that have the best networks of founders and get into the best deals, you have a better chance of having an above-average return,” White said.

Keep them in their seats

Andrew Grant, the director of manager research and investment solutions at the Los Angeles-based wealth manager Kayne Anderson Rudnick, said he’s not ready to go so far to say the criteria defining who counts as an accredited investor should be lowered.

“But the public market is shrinking, and it’s been shrinking for a long time,” he said. “So now everybody’s kind of chasing the same names.”

Grant agreed that the illiquidity of private markets can help “keep people in their seats” when they might be tempted to sell off investments in an economic downturn. Investors who didn’t dump their stocks when markets tanked in 2022, he noted, have most likely made up their losses by now.

Investors in private firms and funds, he said, are in a sense allowing their money to be committed to the furtherance of long-range plans. Free of the distraction of having to justify their existence to shareholders every quarter, private managers tend to have greater leeway to concentrate on long-term plans.

“And you don’t want the you’s and me’s of the world panicking and hitting the sell button and ruining it for other people that want to see this play out,” he said.

Because of the illiquidity of private vehicles, investors are often told not to put in any money that they might need in the near future. That’s another reason why these investments tend to be reserved for the wealthy.

Lowering the liquidity barrier

But recent innovations have helped ease this liquidity barrier.  

Some private investments these days are structured as “interval funds.” As their name implies, they let investors pull money out at set intervals, often once a month or quarter.

But they’re rarely still as easy to pull money out of as public markets. Most private funds of this type have what are known as “redemption gates,” which put the brakes on withdrawals when the total amount being taken out exceeds a certain percentage of the fund’s value.

Investors in Blackstone’s private real estate investment trust — a product commonly known as BREIT — recently learned this to their chagrin. Starting in late 2022, Blackstone began deferring clients’ requests to pull money out of BREIT after previous outflows ran up against its redemption gates allowing no more than 2% of the fund to be pulled out in a month or 5% in a quarter.

BREIT didn’t return to being able to meet all of its redemption requests until February of this year. Blackstone reported in a letter to shareholders dated March 1 that it has been able to fill more than $15 billion of withdrawal requests while delivering an 11% annualized return for investors. 

Lifting the veil

The other frequent complaint about private markets is their opacity. Firms supported by private equity or credit tend to be run by small groups of insiders who don’t necessarily have to answer to anyone but themselves. Public companies, by contrast, come with many layers of regulation and boards that have to report at regular intervals to shareholders.

Miguel Sosa, the head of market research and strategy at the New York-based alternatives firm BlueRock, said most asset managers who are considering investing in a private company will first sign a nondisclosure agreement and then become privy to its internal bookkeeping.

“That opens up the doors to not only financial statements but also operations and administrative procedures; everything can be evaluated by the sponsor in ways that often can’t be done in publicly traded companies,” Sosa said. “Because as long as there’s going to be a significant equity owner and they want to know what they’re buying, diligence is absolutely essential.”

Grant of Kayne Anderson Rudnick agreed that private fund managers are willing to supply audited statements and other documents that should help ease the minds of wary investors. But to get the right sorts of assurances — and to know when you’re been given the runaround — you usually have to know which questions to ask.

That’s where having a good financial advisor, Grant said, practically becomes a necessity.

“We’re talking a multi-month, sometimes a yearlong process to a manager,” he said. “Regardless of what people’s thoughts are on the private markets, we’re going to do our work and we’re going to assess the manager. We’re going to look at their history of making sales and purchases within the fund. We’re going to look at their accounting. We’re going to look at their deals and holdings in the portfolio.”



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