Alternative Investments

Increased Access to Private Markets Expands the Opportunity Set for Financial Advisors

Rapid change is occurring across the wealth management landscape. As with other industries, much of that transformation is being led by technological innovation. Those breakthroughs are enabling financial advisors to deliver holistic and customized advice at levels not previously seen. Distinguishing a wealth management business on these fronts has become essential to maintaining a competitive advantage and growing the business.

Economic conditions and market changes are only further complicating these transitions. Persistent low interest rates and an evolution in public equity markets that has resulted in a considerably smaller opportunity set have reshaped the traditional investment landscape. What’s more, the size and the class of an investor is declining in importance when it comes to their demands and the investment opportunities they are offered. As a result, advisors seeking to remain competitive in this increasingly complex landscape need to expand their capabilities. Today, this often includes providing access to private alternative investments.

Alternatives such as private equity, private debt and private real estate offer enhanced diversification and return potential and have been a mainstay of institutional investor allocations for decades. High-net-worth and retail investors, however, previously had limited access to these strategies due to barriers such as high minimum investment size, limited liquidity and burdensome documentation.

In the new paradigm, high-quality private alternatives are now accessible to qualified purchasers, accredited investors, and even retail investors through fund structures that offer investment minimums as low as $25,000 and highly simplified straight-through processing, which reduces the friction of execution. With all these changes, wealth managers can take advantage of a much wider opportunity set for almost every client, and their ability to deliver comprehensive support and advice will be what differentiates them in their markets.

Why Private Alternatives

Private alternative strategies accomplish several objectives. First and foremost, they can improve the efficiency of capital deployment by providing the opportunity for better risk-adjusted returns, access to unique return drivers, and better downside protection relative to a liquid market index. Investments in private credit and real estate can also enhance a portfolio’s ability to offset inflation risk, which is particularly important when the goal is to generate more income from the fixed income allocation. A recent Cerulli Associates study about why advisors use alternatives confirmed that the top three reasons are:

·        Diversification from publicly traded markets (cited by 84% of advisors)

·        Volatility dampening/downside protection (59%)

·        Current income (59%)

Furthermore, private markets – and within that one could include digital assets — tend to provide higher levels of diversifying idiosyncratic risk and excess returns. There are a number of reasons for the attractive risk/return profiles:

·        Private equity funds take a more hands-on, longer-term approach with relatively more concentrated portfolios that can maximize returns for investors. They also tend to be at the forefront of major market trends, such as digitization and decarbonization.

·        Private debt, direct real estate, and structured credit funds focus more on providing a yield premium to investors by lending against various types of high-quality collateral, such as mid-size company balance sheets, small- to large-scale real estate or other esoteric asset types.

·        Single, double, and triple net lease strategies, non-traded REITs, and non-traded BDCs (business development companies) use more flexible structures to generate alpha, with less portfolio volatility and highly specialized return sources.

·        Qualified opportunity zone strategies in economically distressed communities offer tax-efficient structures, taking advantage of government-sponsored tax incentives.

·        Digital assets may add an orthogonal (uncorrelated) risk factor to a portfolio because of their “network effect” (the exponential increase in the value of a network as it becomes more widely used).

·        Infrastructure debt funds provide direct financing globally for specific projects like toll roads, ports, and airports. These investments can take advantage of inflation pass-throughs, as the underlying cash flows adjust to price increases, they are able to implement in response to inflation.

Liquidity viewed from the proper perspective

Liquidity is an important topic for any type of investment. And the so-called liquidity premium is often associated with private alternatives and considered to be a return driver. To be fair, the fact that an investment is less liquid does not guarantee its success nor does it promise certainty in income generation. Conversely, a highly liquid investment can disappoint and stay in the red for extended periods of time, technically creating a lock-up for investors, unless they are willing to walk away with losses.

In fact, even in the daily liquidity mutual fund/ETF world, the smartest investment strategy has been proven, time and again, to be “buy and hold.” For example, an investor who entered the liquid U.S. equity market in March 2000 would be in a technical lock-up for a decade or more to end up with a meaningful capital gain on that investment. Therefore, liquidity in and of itself should not be the main driver of portfolio construction. But the need for liquidity and diversification, investment horizon, rebalancing restrictions, and an advisor’s due diligence and fund selection capabilities should be driving investment decisions.

The liquidity characteristics of an investment is not what hurts an investor, the mismanagement of liquidity is. Moreover, innovative technological platforms and asset managers’ interest in accessing the high-net-worth/retail market have resulted in the creation of semi-liquid vehicles that were previously unavailable.

Expanding the investment universe for clients

Private alternative strategies offer an expanded universe with unique sources of returns. Increased access to private markets by a far wider range of individual investors enables advisors, regardless of the account size of their clients, to take advantage of end-to-end technological solutions for easy execution and ongoing administration.

Whether the objective is to find investment opportunities created by the new infrastructure legislation, to incorporate ESG-oriented investing, or to participate in the new frontier of digital assets, private markets are now widely available for advisors and many of their individual clients because of today’s much lower minimum thresholds. For advisors, today’s easier access to private markets allows them to greatly expand their capabilities and enhance their competitive positioning. This increased access also provides advisors with more tools to motivate clients to invest and stay invested over the long term.


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