Stocks, bonds, and cash – the three pillars of investment. When your aim is to use existing financial assets to generate more income, these are the three choices that are traditionally laid out before you by a financial advisor or planner. Buy shares in a publicly listed company, purchase bonds with fixed-rate interest returns, or earn interest by putting your money into a cash investment account.
Yet while these three options may remain the cornerstone of most investment strategies, in modern wealth management they are far from the only choices on the table. One of the key principles of successful investment is to hedge your bets as far as possible – spread your investments (and with them the associated risks) around as many different asset classes as possible in order to achieve steady returns even when one or two underperform.
That is why when we build investment portfolios for our clients here at Fiducia Wealth, we always look well beyond stock, bond, and cash markets. And one of the asset categories we make use of is private assets.
What are private assets?
Private assets can most simply be described as those that are not traded on open public markets (such as a stock exchange or government bond issues) but instead take the form of private transactions.
Private assets are considered a form of alternative investment on the basis that anything that isn’t one of the three traditional asset categories is considered ‘alternative’. But not all alternative investments are made in private assets.
Common examples of private assets include:
- Private equity/venture capital: A form of private financing which gives companies an alternative means of raising capital without taking on high-interest loans or floating on a public stock market. Institutional investors such as pension funds, insurance companies, sovereign wealth funds and wealth managers channel capital through specialist private equity firms who broker deals to lend money to businesses in return for a stake (or sometimes buy them out completely). Returns on the investment come when the business or stake is sold in the future. Venture capital is a specialized area of private equity that focuses on start-up investments.
- Real estate: Investing in property with a view to making money by selling it on for a profit or earning income from rents and leases.
- Infrastructure: The mechanism of infrastructure investment works in a similar way to private equity, but the focus is on putting capital into infrastructure projects such as transport, telecommunication, energy etc. Public infrastructure projects will often seek to raise capital this way by creating delivery companies that private investors can back.
- Personal credit: A private lending mechanism in which investors loan money and make a profit from interest in repayments. Unlike private equity arrangements, the investor holds no stake in the company they lend money.
Why invest in private assets?
Investment activity in private markets has been on the rise for more than a decade now, for several reasons. One is the fact that, in times of uncertainty and market volatility, wealth managers and investment funds typically look to cast their net further afield as they look to offset risk.
So after the financial crisis of the late noughties, and again now in the wake of the COVID-19 pandemic, the diversification options offered by private assets become increasingly attractive. But more than that, private assets offer some intrinsic benefits over other asset classes which make them less vulnerable to market volatility and more likely to perform better over the long term.
For example, real estate and infrastructure hold greater intrinsic value than most other classes, and as tangible assets hold their value over time. As we’ve seen with the housing market, growth in real estate can often continue at odds with what is happening in the wider economy. Valuations of real estate and infrastructure also occur much less frequently than, say, the daily reappraisals seen in stock markets, so these asset classes are much less prone to frequent fluctuations which makes return forecasting much easier.
On top of this, analysis shows that private markets have consistently performed better than public investments for the past 30 years. According to McKinsey, private equity has provided better returns than any publicly traded asset over the past 10 years. Similarly, data from Cambridge Associates shows private equity outperforming public equity in US investment markets over five, 10, and 25 years.
One final benefit that draws wealth managers to private assets is the higher level of influence they can exert over investments. Private equity deals, for example, often result in investors or their representatives having a say in the running of a company at the board level or at least forming close relationships with executives which gives them some ability to steer direction. In the case of full private equity takeovers, of course, investors become the de facto owners and can run a company for their own ends.
What are the challenges of private asset investments?
For all of these reasons, private assets have an important role to play in a strong, balanced portfolio where the overarching aim is to achieve positive investment returns with only a moderate level of risk.
However, there are some good reasons why wealth managers are careful not to rely too heavily on private assets at the expense of more traditional markets. Private assets often require high initial investments, meaning you have to have a large amount of capital available to get started with them. Compared to things like share and bond purchases, negotiating deals for property, infrastructure investment, and private equity can be much more complicated, requiring legal expertise alongside financial advisory.
Another drawback with private asset investments is they carry a high level of illiquidity and can tie up capital for many years before returns can be realized. This is fine if the strategic investment objective is long-term growth rather than generating income in the short term. But again, you have to have the capital spare to be able to play this sort of long game.
As with all assets, at Fiducia Wealth we will always recommend investments to our clients based on a detailed understanding of your priorities, objectives, and tolerance of risk. In the interests of creating diversified portfolios that offer a degree of security in turbulent economic waters, we recommend investing in private assets as part of a long-term growth strategy with low to moderate risk. But that has to be based on having the capital available to make investments and also having the financial means to afford to have that capital tied up for a number of years.