Discover why private assets can be a great fit for private investors' portfolios.
Private markets have seen significant growth over the last two decades, with AUM having increased from below $1 trillion to over $13 trillion1 today. Most of that growth has been driven by institutional investors, largely due to lack of access points for non-institutional investors. However, with more opportunities for private investors to access this area today, demand is ramping up. Here, we look at why these asset classes can be a great fit for private investors' portfolios and how it can help achieve their goals.
1. Easier access
Recent regulatory changes and product innovations have made private markets more accessible to private investors.
Historically, regulators deemed illiquid assets unsuitable for retail investors. At the same time, private investors were not willing to lock their money up for years (and sometimes decades) when there were other assets that wouldn't constrain them.
But now, with the introduction of the European Long-Term Investment Fund (ELTIF) in Europe and the Long-Term Asset Fund (LTAF) in the UK, private investors can access high-quality private assets through regulated products in an easier way than traditional private market funds (low minimums, no capital calls, lower fees). These funds can be a strategic additional tool in helping individual investors achieve greater diversification and potentially a return pick-up on their public market portfolio.
These evergreen, or semi-liquid, structures are also an attractive alternative to traditional closed-ended funds for private investors due to mechanisms that address the long capital lock-ups associated with private assets. These funds offer periodic liquidity access (typically quarterly) within a simpler framework and typically at a lower cost.
However, private assets remain inherently illiquid. While evergreen structures can improve liquidity options, these aren't without limitations. The potential need to limit redemptions in challenging markets to protect investors needs to be considered. Wealth managers should bear such factors in mind when determining the size of semi-liquid positions within their clients’ broader portfolio.
2. New macro regime
The shifting market landscape and economic uncertainties in recent years has served as a wake-up call for private investors. Higher interest rates and inflation have highlighted the vulnerabilities of public markets – and with higher correlation between stocks and bonds becoming more apparent, the importance of diversification and the incorporation of new asset classes into portfolios has never been more essential.
Private markets shouldn’t just be considered as an alternative, but as a key source of returns for clients’ portfolios, as market volatility is likely to persist in the future.
At the same time, private investors have been captivated by the potential to harness major secular trends like decarbonisation, demographic shifts, and disruptive technologies. These trends are not just reshaping our world, they're also unlocking a wealth of long-term investment opportunities. These trends are largely driven by private companies, making private markets a hotbed for innovation and disruption.
The key opportunities can be found in themes such as:
AI revolution - driven by venture and growth capital investments in private equity.
Energy transition - driven by infrastructure equity and debt investments into wind and renewables and, partially, in hydrogen, as well as by private equity investments into the renewable energy value chain.
Emerging market growth (i.e. Indian private equity) as well as emerging market impact, via microfinance.
Aging populations (biotech, healthcare services and senior living), which could be accessed via private healthcare investment within private equity.
3. Broader investment scope than public markets
When looking to diversify clients’ portfolios, private markets can be a powerful tool, because they offer a much wider spectrum of opportunities than what public markets currently offer. This trend is driven by companies staying private for longer, securing funding from private capital instead of going public.
Today, in the US, less than 15% of companies with revenue exceeding $100 million are listed on the stock market2, creating a vast pool of targets for private equity, particularly in small to mid-size buyout markets. Moreover, only a fraction of the universe of private companies are owned through institutional private market fund structures, suggesting growth potential in this asset class for private wealth.
Buyout companies frequently remain under private equity ownership, often transitioning from one private equity fund to another. With the advent of GP-led continuation vehicles, these companies can remain privately held under the same fund manager, but with new investors, for even longer.
The increased availability of funding has led to a delay in initial public offerings (IPOs), meaning companies tend to go public several years later than they would have a decade or two ago.
In the world of debt markets, traditional bank lenders have retreated from many markets due to regulatory changes following the financial crisis, paving the way for private lenders and growth in the private debt industry.
4. Potential higher returns/income
Private markets are rapidly becoming the go-to arena for wealth managers and advisers seeking that extra edge. One of the top reasons for that is the potential for higher returns than what they can get in public markets. Unlike institutional investors, who typically align investments with specific future liabilities, such as pensions or insurance companies, private wealth clients can prioritise maximising returns, accepting slightly higher risk for the potential of increased performance.
The additional income private clients can get from assets such as real estate, infrastructure or private debt, is another attractive point.
In private equity, buyouts have outperformed US large and small caps by a significant margin (net of fees) over the long run. Our research shows that the persistence of returns is greatest among small funds, strong and significant among medium-sized funds, but weak among large ones. This could also be a way for private investors to avoid more crowded parts of the markets, for example large funds or deals, to diversify their exposure further.
Historically, private assets have also demonstrated performance resilience. During times of crisis over the last 25 years, such as the Global Financial Crisis and the Covid pandemic, private equity outperformed public markets by 8%, with much lower volatility and maximum drawdowns.
The allure of private markets for private investors extends beyond just the 'illiquidity premium' - the price discount or extra yield offered as compensation for capital being locked up. The complex nature of transactions can generate a 'complexity premium', a reward for investment managers who can navigate these intricate deals. Moreover, an investment manager's expertise in identifying and executing deals can significantly boost returns, making private markets a highly attractive investment proposition.
5. Diversification
Diversification is a top priority for private investors in today's volatile markets. Not only are they seeking higher returns, but wealth preservation is also a key concern. To address these needs, many are turning to private markets for their broader spectrum of risk/return drivers. Wealth managers should guide their clients in understanding these nuances to understand the role these assets can play in portfolios.
Private investors should consider diversifying their exposure within the asset classes in private markets, much like they would with listed assets. For instance, diversifying across private equity, private debt, infrastructure and real estate can emulate the strategies used by institutional investors, potentially enhancing returns and mitigating risk.
Within the same asset class, diversification is also important. For example, private equity is not a one-size-fits-all strategy. It encompasses a range of strategies - venture capital, buyouts, growth equity, turnarounds, secondaries, and more – and each of these strategies has distinct risk/return and liquidity profiles. Large private equity buyouts may be closely tied to public markets, while smaller buyouts and venture capital investments, especially in early-stage companies, are more influenced by product development and initial customer acquisition.
Renewable infrastructure assets, such as wind and solar, can offer a return premium over gilts, providing cash flow stability and reduced sensitivity to economic cycles. Thanks to stable cash flows from government contracts, these can potentially be lower-risk investments.
Private credit encompasses a range of strategies offering attractive income opportunities that take advantage of market inefficiencies, and that provide a valuable alternative to public debt markets that are trading at historically low risk premiums. In addition, many of these strategies employ floating rate structures, providing a hedge against rising interest rates, counterbalancing the volatility caused by interest rate fluctuations.
Ultimately, the choice of investment depends on the clients' risk tolerance and investment needs. At a fund level, whether they prefer semi-liquid solutions to invest for the medium to long term, or non-liquid options for longer-term returns, a diversified approach across different asset classes and strategies within private markets can help align with their long-term objectives.