Potential Benefits of Private Market Investments
The investment management industry is primarily built to serve two main types of investors — individuals/families and institutions. These two client types have very different needs. Individuals and families tend to want to live a comfortable lifestyle, support their children and have enough assets to last throughout retirement. Individual investors also require a certain level of portfolio liquidity in case of emergencies or unexpected expenses. Retail investments are specifically designed to help individuals achieve these objectives.
On the other hand, institutional investors, such as pension funds and endowments, are typically managing multiple millions to billions of dollars in assets. Their objectives tend to revolve around maintaining assets over many decades, oftentimes in perpetuity. They are not as concerned with liquidity and are able to invest more aggressively given their longer time horizons.
Ultra-high-net-worth (UHNW) investors don’t fit neatly into either of the typical investment categories. While they are individuals and families investing to support their lifestyles, they may have a much longer time horizon (as they strive to build lasting multi-generational wealth). From an investment perspective, these UHNW investors often share more characteristics with institutions than with a typical retail investor.
At Creative Planning, we understand UHNW investors often require a different investment approach. That’s why we typically recommend an allocation to private market investments. We define private investments as any investment in private equity, private credit, private real estate, private infrastructure or private hybrid funds.
Benefits of private market investments
We believe most UHNW investors should look beyond public markets and consider an allocation to private investments, as they offer risk mitigation, diversification, enhanced return potential and the flexibility to capitalize opportunities.
Enhanced return potential
Private investments have the potential to generate higher returns than traditional asset classes. For example, recent data highlights that, as of December 31, 2023, private equity funds delivered a 25-year average annual return of 13.1%, compared to the S&P 500 Index’s return of 8.6% over the same period.[1] Similar disparities in returns are noted in the chart below, which reflects private equities’ potential to outperform the S&P 500 Index over 5-, 10-, 15- and 20-year periods.
Similar outperformance has also historically occurred between private and public credit, as illustrated in the chart below.
Flexibility to capitalize opportunities
When major disruptions occur in the economy, such as the COVID-19 pandemic or the subprime mortgage defaults of 2008, private market investment managers have the flexibility to quickly establish new strategies to meet investors’ evolving needs. This flexibility can allow private investors to capitalize on short-term opportunities and market dislocations.
In contrast, retail investments must navigate a lengthy process for establishing a new investment strategy. Often by the time a new strategy is launched, the opportunity has already passed.
Risk mitigation
Private equity investments are typically less correlated to overall market trends than public investments. This low correlation can help buffer an investment portfolio against market volatility, because it provides an opportunity to access returns that differ from traditional stocks and bonds.
Diversification
Private investments are available across a wide range of investment types, markets, strategies and investment managers, which makes them a great way to add diversification to your investment portfolio.
Potential drawbacks of private market investments
The benefits discussed above don’t come without some potential drawbacks. It’s important to be aware of these as you consider investing in private investments.
Illiquidity
Private investments aren’t held to the same pricing and reporting standards as publicly traded investments. While this difference can be an advantage when it comes to the ability to quickly pivot an investment strategy to access market opportunities, it also leads to illiquidity. Some private investments remain locked up for 12 years or more, and you may not be able to access your funds during that time. Before investing, it’s important to make sure you’re comfortable giving up access to your investments for an extended period of time.
Higher fees
Private investments typically charge higher fees, including management fees, ongoing service fees, incentive-based compensation for the asset manager, redemption fees and more. Be sure to carefully review any offering documents for all fees and expenses prior to investing.
High risk
Certain private investments are highly speculative and volatile. While these are the characteristics that give private investments the potential to result in high returns, they can also lead to significant losses. Your wealth manager can help you determine whether the benefits of a particular investment offset the added risk.
Complexity
Private investments can add significant complexity to your investment portfolio. Many of these strategies have complex investment structures that can be difficult to understand. In addition, private investments can have significant tax implications.
Private investments aren’t typically regulated in the same manner as traditional investments, and they aren’t held to the same reporting requirements as public investments. In addition to tax and liquidity implications, this difference can lead to challenges with both transparency and pricing.
