With investors in the public markets facing obstacles ranging from increased regulatory scrutiny to severe volatility, private markets are continuing to grow in popularity among high-net-worth individuals.
Popular private markets
‘Private markets’ has become an umbrella term to refer to assets that are not liquid, are not traded on organised market exchanges, and are spread across different segments such as private equity, real estate, private credit, and infrastructure.
The rise of private markets has been one of the biggest financial trends of the past decade. Once an asset class only available to big institutional investors such as large North American pension funds or endowments, private markets have expanded hugely in recent years and have become increasingly accessible to private investors. The secular bear market of the 2000s created the perfect environment for private markets – those where assets not traded on public markets change hands – to flourish. Encompassing sub-categories from art and collectibles to real estate, infrastructure, and private equity, private market investments have increased hugely in recent years. Private equity investments alone almost tripled in a decade, from approximately USD 1.6 trillion in December 2009 to nearly USD 4.5 trillion as of December 2019.
That market-to market volatility in a portfolio can make for sleepless nights for wealthy individuals as it is difficult for them to ignore.
Unsurprisingly, private equity is the most popular form of private market investment. From venture capital to investing in long-established family-owned companies, private equity offers a wealth of opportunities. Today, over twothirds of all institutional investors have private equity in their portfolios, and according to global consultancy Knight Frank it now accounts for 8 per cent of a typical investment portfolio among high-net-worth individuals. Indeed, investment in non-listed entities was the most popular request to wealth managers from ultra-high-net worth (UHNW) individuals in 2021, according to the Julius Baer Family Barometer.
Most popular sectors for private investment
According to a report from consultancy McKinsey, the most popular sectors for private investment are real estate, energy, professional services, software, and healthcare. Meanwhile, travel, hospitality, and media have become less popular in the past 10 years – and these sectors are likely to continue to face disruption from the Covid-19 pandemic over the next few years.
A perfect storm
There are a number of factors that play in favour of private investments at the moment, as Yves Bonzon, Chief Investment Officer of Julius Baer, explains: “First, increased regulatory scrutiny in the public markets combined with demanding conditions for listing have contributed to a tendency for many companies to remain private, or to stay private for longer, which has enriched the market considerably.” Second, as seen with the 2008 crash and again when the pandemic hit in 2020, liquid markets in particular can be tremendously volatile in the short run. “That market-to market volatility in a portfolio can make for sleepless nights for wealthy individuals as it is difficult for them to ignore,” Bonzon says. “With private markets, on the other hand, you don’t see the day-to-day price fluctuations.” This has the advantage of making private investments feel more stable and reduces the tendency among investors to change their positions too frequently.
Third, private markets also have an element of exclusivity around them as not everyone can invest in companies pre-IPO, and that exclusivity is driving the appetite for such
investments among wealthy investors, and family offices in particular. However, Bonzon notes it is important to remember that overall, private markets might not provide better returns than public markets, so the added complexity of adding private equity to your portfolio only makes sense for larger asset bases: “The additional complexity will not make much of a difference on a USD 2 million portfolio in absolute terms. When it’s on a USD 200 million portfolio, however, the enhanced risk return profile may, in dollar terms, be worth that additional complexity.”
Finally, increased interest in responsible wealth management – 27 per cent of high-net-worth individuals have expressed interest in sustainable investing options, according to data from Capgemini – means that investors are looking to back companies, corporations, and funds that generate financial returns alongside measurable social and environmental impact. As Bonzon explains, “Private equity is one of the asset classes likely to have the most tangible impact when it comes to fulfilling environmental or social objectives, as invested capital is typically directly used by the company to fund projects with clear environmental, social, and governance (ESG) characteristics.”
No upside without a downside
Of course, as with every investment, there are risks and considerations, and private market investments are no exception. One of the biggest considerations is the lack of transparency inherent to the asset class. In comparison to listed companies, which have extensive regulatory reporting requirements that reveal a great deal about the health and workings of a company, there is relatively little information available to investors about the inner workings of private companies.
Furthermore, in comparison to companies listed on the major stock exchanges, where you can measure the returns in precise detail for any given period down to the last dollar, the lack of transparency on returns in private markets, coupled with the fact that there is a time lag before you even get the figures, makes it very hard to capture exact returns.
As mentioned, this can be an advantage as investors do not see the price fluctuations and are therefore less inclined to rearrange their positions in moments of panic. However, it also has drawbacks – the biggest of which are the additional costs paid by the investor to compensate for the extra work associated with private equity along the value chain. A typical private equity portfolio is likely to charge close to 600 basis points, 10 times more than a standard portfolio of publicly listed companies – a hefty premium to pay not to see the price changes.
Another point worth bearing in mind is the lower liquidity in private markets. Secondary markets for private investments exist, but volumes and market making are subdued – particularly in times when they are needed most. Therefore, compared to the rest of your portfolio, you will need more confidence that you are able sit on private investments for an average of seven years.
The final consideration is that when it comes to private equity in particular, there is a significant difference between the size of the investment and the money you actually put to work. For example, if you are investing over a long time horizon, you will often only have half of the committed money at work at any particular time, so it is not unusual for end-investors to commit twice as much money as they actually intend to invest. And what’s more, you pay fees to the investment manager on the committed amount.
Most popular regions for private market developments
When it comes to regions that are ripe for private market developments, Asia is leading the pack. The large number of entrepreneurs and the emerging market economy make it fertile ground for private market investments. That said, there is an expectation that investors will become more selective among sectors and private equity firms given recent events in the region.
Looking to the future
Yet, despite these potential concerns, private market investments continue to grow in popularity and investors are increasingly looking for ways to access the markets more directly. There are also early attempts to further democratise access to private markets, with digital newcomers such as Moonfare, OurCrowd, and Verve looking to give private investors, potentially even retail investors, access to the asset class through digital interfaces. Whether this will work is yet to be seen.
Private market investments themselves, though, are here to stay. As with any good investment strategy, it is important to be diversified, and private markets offer excellent diversification opportunities for wealthy investors. However, in all the excitement around private markets, and private equity in particular, it is important not to discount or underestimate public market equities – after all, as Bonzon adds, “They tend to have underappreciated merits.”
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In the latest issue of Julius Baer's 'Vision' magazine, we take a broad look at markets in all their facets. From a revolutionary new stock exchange for long-term investors, and the growing popularity of private markets among HNWIs, to the technological transformation that has taken place in trading in recent decades.
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