Much has been written about the democratization of private assets; the catch-all term for a range of changes expanding access to the private market beyond its traditional institutional clientele. However, it could be argued that the talks of democratization as a theme have not been framed in the right way, which has caused confusion among some investors.
Much of what has been written about democratization portrays it as a budding revolution. I see it more as an evolution. Retail investors have had access to private assets through investment trusts for decades. The options have multiplied in recent years, however, and they will continue to do so.
Being convinced that many clients could benefit from an allocation to private assets, it remains that the relevance of this allocation is essential. Democratization simply means that access becomes less problematic.
What are the different options for accessing private assets?
Below is a rudimentary illustration of the main structures available for investing in private assets today. Each structure has its own liquidity profile, and varies accordingly depending on the nature of the investments within, as well as fees and minimum investments. This is illustrative only and should not be taken as investment advice or a recommendation to buy or sell.
As mentioned, listed, closed-ended private asset vehicles (or investment funds) have been around for a long time, with a claim to be the first “democratized” options. However, the developments have modernized the structures and helped solve some of the problems the structure may have.
Liquidity for traditional investment trusts (ITs) under normal market conditions is good, with intraday trading available. This liquidity profile is what has traditionally determined their potential suitability for more retail or “high net worth” investors.
In traditional IT, the share price can move independently of the declared net asset value (NAV). Investors may face a situation, if they sell, where the stock price is at a (potentially significant) discount to the net asset value. Many investors favor the IT structure precisely for this reason, attracted by the possibility of profiting from a dislocation between the trading price and the intrinsic value, but this must be taken into account when making a decision to invest in these assets.
Obtaining liquidity has caused some problems in the past, with isolated instances of unfavorable market environments compromising the ability of sellers to find a willing buyer on the other side. This should be managed, in our view, through appropriate portfolio construction and with due consideration of each client’s circumstances, such as time horizon, risk appetite and need for liquid access to their capital. . But it is also where the important developments mentioned above have been made.
Technology has been instrumental in the growth of cashless or periodic cash feeder funds available through web-based platforms. These new closed-end fund structures are designed specifically for retail investors, by having a structured capital call schedule, shorter fund duration than more institutional funds, and lower minimum subscription amounts.
Semi-liquid options are the fund structures that occupy much of the democratization spotlight right now, as many of the most important product developments have occurred in this space.
Where semi-liquid funds are taking over from listed vehicles is in terms of subscription amounts. These funds often have no minimum subscription amount when invested through a professional adviser. Subscriptions and redemptions are made at the net asset value (NAV) of the fund. This removes market volatility or beta compared to closed-end funds, which rely on a secondary market for liquidity where the price you receive is at the mercy of supply and demand dynamics.
This also means that the liquidity is not as high as for listed closed options, as the funds have the ability to ‘lock in’ when certain thresholds are exceeded. For clients more interested in the semi-liquid structure, they are generally more concerned about illiquidity and have less capital to deploy. A clear assessment of a fund’s mechanics for providing liquidity is crucial for any wealth manager allocating client capital to this fund structure.
Fund of funds solutions
While fund-of-funds solutions have to some extent lost popularity, they remain a relevant way for private investors to build a well-diversified exposure to private assets.
Minimum amounts vary by regulatory status. As these are generally closed-end funds, the investor must forego the flexibility of listed vehicles. Due to their nature, capital deployment can often take longer, with an investment period of up to five years.
Funds of funds and semi-liquid funds may have an allocation to venture capital, as well as to small and medium enterprises and certain large buyouts. Very large investors may find it difficult to access smaller companies, perhaps due to internal risk controls, but funds of funds can “cut” their investors. Conversely, retail investors can “scale up” to access more and larger funds than they otherwise could.
While fund-of-funds diversification is naturally higher, so are all-in costs. Where we’ve seen more client interest in the fund-of-funds space is for investors who are happy and able to tie up their capital for longer periods of time and want broad exposure. diversified to private assets.
Investment in a single fund
The final fund structure option that selective clients have for accessing private assets is investing in a single fund. Here, the minimum subscription amounts are higher than elsewhere, although they have decreased in recent years.
However, the liquidity profiles are often very different. We generally offer these types of investments in private assets only when an investor can manage an investment term of more than ten years. The life of the fund will often include an investment phase and a ‘harvesting’ or distribution period. For some investors, it may seem like a long time to lock in capital. However, we have seen countless examples over the years of clients maintaining liquidity profiles in larger portfolios that they do not need.
Another risk consideration in single funds is that diversification is lower than in fund-of-funds and semi-liquid vehicles. However, the added benefit is that the overall fees tend to be lower. We have found that our larger and more sophisticated clients express the most interest in these types of funds and are happy to take on more concentration risk in the hope of earning higher investment rates of return.
Why integrate private assets?
Some of the comments made earlier in this article may deter some investors from investing in private assets. Indeed, market conditions at the time of writing have certainly created an air of caution.
Nevertheless, I believe that an allocation to private assets, as part of a multi-asset strategy, can improve the risk-return dynamic of a portfolio.
There are three main reasons for this:
- The set of opportunities – Investing in private markets allows clients to access a set of opportunities not available in public markets. Recent data from Hamilton Lane points out that 87% of US companies with over $100 million in revenue are in private hands. Evidence also shows that companies stay private longer or don’t even choose to register at all. By not allocating to this asset class, you are missing out on a huge investment universe.
- Improved yields – there is strong historical evidence to show that private markets have generated superior returns to public markets on a net of fee basis. This is due to the illiquidity and complexity premiums of the asset class. While past performance is not indicative of future returns, we believe market depth and manager skill will continue to drive this trend going forward.
- Benefits of diversification – The data suggests that an allocation to private assets improves diversification across risk profiles. Private asset valuations are updated only infrequently and are not often “marked to market”, i.e. fixed to reflect movements in public markets.
Both characteristics mitigate the reported volatility. It is reasonable to expect that the return pattern of a portfolio of investments in private markets will be different from returns in stock or bond markets. This is especially true if the portfolio is diversified across sub-sectors and vintages within private markets.