Differentiating Your Practice Through Private Investments
High-net-worth investors (HNWIs) increasingly want far more from their advisors than a public market model portfolio, with demand for private investments on the rise. A combination of three factors means that wealth managers should probably find ways to offer private funds to their clients:
- The investment environment has changed, potentially in a sustained way
- Clients are increasingly demanding access to alternatives
- Both competition for wallet-share and client mobility in the HNWI space have increased
The investment environment has changed
For most of the last forty years, the traditional 60/40 equity/bond portfolio’s performance was supported by muted inflationary pressures and declining interest rates. In 2022, that changed, as the strongest inflationary pressures since 1980 forced the US Federal Reserve to tighten policy at the expense of growth.
A combination of high inflation and elevated interest rates pushed down the stock market sharply in 2022: The S&P 500 fell 18%. And the bond market – traditionally a hedge against stock declines – lost over 13%. It remains an open question as to whether stocks and bonds have “re-correlated” (i.e., returned to moving in the same direction) after two decades of negative correlation, but a positive correlation between stocks and bonds is far from unprecedented. Returns from stocks and bonds were positively correlated for three decades from 1970 to 2000 (see chart below) when inflation and interest rates were key macroeconomic drivers.
Advisors will want to watch stock and bond movements carefully, because the implications of a “re-correlation” are huge, demanding a rethinking of bond allocations and a fresh search for assets that can effectively hedge equities. While both stocks and bonds have been up since the turn of the year, general economic uncertainty remains, and the 60/40 may be vulnerable should inflation surprise to the upside or growth surprise to the downside.
Elsewhere, during prior periods of high inflation and increased market volatility, many investors have turned to gold for its purported ability to hedge against inflation and provide portfolio diversification. Unfortunately, in 2022, gold did not trade like a store of value, producing a negative return even as inflation rose to multi-decade highs.
All of which argues for seeking alternative, differentiated sources of performance for your clients.
We would suggest that the active management of private funds may allow for strong relative performance in any investment environment, and that consistent investment over a number of years is the optimal approach by which to create a sustainable private markets program for clients. However, the data also shows that periods with falling performance have historically been a good time to deploy capital for most private asset classes, given that they may be able to take advantage of recent company valuation declines to buy assets at a discount.
Clients are increasingly demanding access to alternatives
HNWIs had already been demanding a greater range of options from their wealth advisors, prior to 2022’s turbulence. A Cerulli Associates survey found that HNWIs had an average of 9.1% of assets allocated to alternative assets, and that the advisors surveyed expect this to increase to 9.6% by 2024. A whopping 94% of surveyed HNW practices expected to maintain or grow their positions in alternative strategies, excluding hedge funds.
Recent market performance will have only served to heighten this demand. Clients may be seeking multiple different benefits from private market exposure, including:
Diversification: Private funds offer exposure to a very different underlying universe of companies and assets that are inaccessible via public markets. As such, they may have different return drivers, which can help clients diversify their portfolios and potentially reduce overall risk.
Enhanced returns: Certain private asset classes (for example, private equity and venture capital, highlighted in the chart below) have historically outperformed the public market, particularly among the top-performing managers, which may help clients meet long-term growth objectives.
Tailored exposure: Private funds can be structured to meet specific client investment objectives, such as generating income, preserving capital, or achieving specific social or environmental outcomes via impact funds.
That said, as the charts above imply, private fund investments may carry higher risks compared to traditional public market investments, as well as higher fees to pay for their active management. In addition, they typically offer limited and intermittent liquidity at best. As such, they may not be suitable for all clients. Advisors should holistically evaluate risk tolerance, investment objectives, and liquidity needs to determine whether private funds are suitable for a particular client.
Increased competition for wallet-share and greater client mobility
On top of the uncertainty around public asset performance and greater awareness of private markets from clients is the rising competition for wallet-share, as HNWIs show a growing willingness to switch advisors in search of better service or investment options.
In a recent survey by PwC, more than a quarter of affluent clients indicated that they had changed advisors in order to access differentiated products and services. It also found that nearly half (46%) were planning to change wealth management providers and/or add new relationships in the next 12 to 24 months. This was particularly true for those looking to invest in alternative assets (see chart below).
The twin goals of protecting current business and capturing new business may therefore both be well served by adding private market fund options to your product range. The risk to your practice of not doing so appears to be growing.
This may require some effort to establish, particularly for advisors or practices that do not have huge scale or resources in-house. Sourcing, selecting, and accessing the best private market funds requires significant expertise, so for smaller practices, finding a partner might be the most cost-effective, quickest route to offering a compelling private market program. There are a number of platforms out there, but you should make sure that their interests are genuinely aligned with yours, that they can offer guidance across the full investment process, and that they have truly differentiated fund access.
In our view, offering a genuinely differentiated private market product platform, and supporting that with investor education and streamlined proposal and reporting capabilities, will put you in a good place to not just weather the challenges discussed above, but actively capitalize on the growing interest in alternative assets and grow your practice.
The second blog post in our series will look in more detail at the administrative processes involved in establishing and maintaining a private markets offering for your clients.
Opto Investments is a technology-enabled end-to-end solution designed to help RIAs craft tailored private market investment portfolios comprising funds from coveted managers in private credit, private equity, real estate, venture capital, and infrastructure. To start a conversation with us about helping you build out custom private market exposure for your clients, please visit our website.
Jacob Miller is a co-founder and Head of Advisory Services at Opto Investments. Visit our partner page to learn more.