Ever wonder how the most sophisticated consultants and highest-rated portfolio managers allocate investments for their large, institutional clients/?
Although it might not surprise you to learn that they do things a little differently than your average retail investor, you might not know that it’s possible for many individual investors to assemble similar portfolio allocations and essentially ride along with some of the same top-quartile funds found in those multibillion-dollar institutional portfolios.
The biggest difference is a sizable allocation to private market investments, or alternative investments, in institutional portfolios. For example, according to a trio of 2022 reports — Preqin Global Private Equity Report, Hodes Weill & Associates: Institutional Real Estate Allocations Monitor and UBS’ Global Family Office Report — sovereign wealth funds, on average, allocate 28% to private markets, public pension funds allocate 31%, foundations 34%, college endowments 37%, and family offices 38%.
Many retail investors allocate little if anything to private market investments, though admittedly non-accredited investors generally can’t due to eligibility requirements.
But that’s changing, along with access to more investor-friendly fund structures enabling accredited investors to purchase heretofore inaccessible private funds with modest investment minimums, no capital calls, 1099 tax reporting, monthly (or even daily) pricing, and quarterly liquidity.
These new alternative investment funds aren’t suited for, or available to, every individual investor in the same way a mutual fund, or exchange-traded fund, generally is. But many accredited investors can purchase these private market investments, affording them many of the same benefits accruing to large institutional investors.
What are those benefits? In short, higher returns along with lower volatility and drawdown risk. Historically, many institutions found that blending private market, alternative investments into a traditional portfolio consisting of publicly traded stocks and bonds reduces risk through the addition of uncorrelated asset classes, extending and improving diversification, yet these alternatives also consistently offer higher returns.
In an annual CAIA Association performance study, for example, private equity allocations by state pension funds outperformed public stocks by 4.1% annually, on average, over a 21-year period. In its March 2023 Insights publication “Regime Change: The role of private equity in the ‘traditional’ portfolio,” KKR Global Institute found the following: “Over three decades, Private Equity has — on average — empirically delivered excess returns of about 4.3% on a net annualized basis. This relationship also holds true across regions and cycles over the long term.”
Apollo Global Management, in a May 2023 paper titled “Beyond Beta: How to Use Alternatives to Replace Public Equity,” illustrated that, over a 14-year period ending in September 2022, private equity provided 3.2% annual outperformance as compared to the S&P 500 index, with 8.7% lower volatility and 17.3% lower drawdown. Morningstar found that over a 36-year period, private equity outperformed public stocks by 4.7% annually, with 6.5% lower volatility.
If investing in private markets seems scary or reckless, consider that private markets are roughly 10 times larger than the public market. As of April 2022, Capital IQ reported, 92% of all companies with annual revenues greater than $100M were private, with the other 8% being the more commonly known publicly listed and traded companies. In 2018, the Kaiser Family Foundation published “Number of Private Sector Firms, by Size,” estimating that there were 7 million private companies in the United States.
But private firms are certainly less well known by the public, and the private investment market is definitely more opaque, requiring investors or their advisors to carefully review fund-specific data and information. Manager dispersion of investment returns is much greater among private market funds and managers, compelling many accredited investors to hire specialty advisory firms well versed in the private markets, with access to the top funds and managers.
Due diligence is a must before considering any investment in a private market fund, whether private equity, venture capital, private credit, private real estate or private infrastructure.
Another important aspect of privately funded firms is that because they’re not subject to the same SEC regulatory framework as publicly listed and traded corporations, management can make decisions based on longer-term, more strategic issues. Private companies aren’t required to file 10-Q forms and release their earnings every three months, enabling a longer-term focus with less concern for daily stock price swings. Private market investors can also benefit from active participation in the direction, management and implementation of private firms’ businesses.
Many private equity fund managers, for example, have a team of seasoned and skilled executives, as well as knowledgeable specialists in such areas as finance, distribution, marketing, sales, artificial intelligence, technology, networking, human resources, legal, robotics and cybersecurity. These professionals, who work for the private equity fund managers, are regularly plugged into specific portfolio companies to help those private firms in areas or disciplines most needed, enhancing the potential of success for those businesses — and by extension, increasing the potential for higher investment returns.
With this potential of higher returns, of course, is also the potential for higher volatility, lack of liquidity and lower returns compared to the public markets.
Fund Options
Here are a few examples of “democratized” private market funds — in no particular order, and not intended as a recommendation for purchase:
Blackstone, the largest private equity firm by assets under management, offers sub-accredited retail investors access to its private real estate and private credit platforms through the fund structures employed by BREIT and BCRED, respectively.
Investment minimums are $2,500 for each Blackstone fund, no capital calls are employed and 1099 tax reporting simplifies these investments. Qualified purchasers with at least $5 million in qualified investments can now mirror Blackstone’s institutional investors on their flagship private equity buyout/drawdown platform by investing in BXPE, a recently launched investor-friendly private equity fund intended for individual retail investors.
Kohlberg Kravis Roberts & Co, another large private equity firm, has a similarly structured KKR Private Markets fund and a KKR Real Estate Select Trust, both generally available to accredited investors with $10,000 to $25,000 investment minimums.
Stepstone, one of the largest allocators to private markets on behalf of their institutional clients, offers three funds intended for accredited retail investors. SPRIM is a core private markets fund investing across all private asset classes, whereas SPRING invests specifically in mid- to late-stage venture firms. Stepstone’s private infrastructure fund, STRUCTURE, was launched recently and features daily pricing, similar in that regard to SPRIM.
Ares, one of the top private credit firms, recently launched ASIF, a retail investor-targeted fund managed by the same Ares Credit Group that has been in place since 2004. Similar in structure to Blackstone’s BREIT and BCRED, ASIF is available to sub-accredited investors with a $2,500 minimum.
Conclusion
It’s certainly an exciting time for accredited investors wishing to implement institutional-style portfolios, now that many of the largest and most respected private firms are democratizing some of their flagship funds, providing accredited retail investors access to private asset classes heretofore unavailable. This opens a whole new opportunity for some investors to better diversify their portfolios to achieve growth targets, limit volatility and drawdown risks, and protect principal in ways formerly only available to large institutions.
To educate retail investors and provide due diligence and private fund access, wealth managers are scrambling to develop best-in-class solutions and service models leveraging this shift in availability and access to private investments.
Scott McClatchey is a senior wealth advisor and CFP with Ballast Rock Private Wealth in Carlsbad, California.