Investors today are faced with many challenges. With the economy emerging from the shadows of the COVID recession, it’s hard to know exactly what the appropriate valuation of the market should be. Some models show equities to be trading at very elevated levels while others, particularly those based on interest rates, instead suggest that stocks are fairly valued.
But interest rates themselves are another problem, as they remain near all-time lows. In fact, today about 27% of the world’s investment grade bonds, or roughly $18 trillion in total, actually have negative yields! Capital appreciation may be uncertain, but income is downright hard to come by.
It should come as no surprise then that investors continue to turn to alternative investments as a solution to their portfolio needs. According to research in Fundfire, sales of private partnerships through RIA and wealth channels increased by 150% in 2019!
Today, high net worth investors have on average a 22% allocation to alternatives broadly – similar to pensions – while ultrahigh net worth investors have even more, closely approaching the alts heavy portfolio construction used by the endowments and foundations for whom they are often trustees.
Date: As of 2018
And the argument for the democratization of alternatives – or increasing access to individual investors – is a strong one. Over twenty-five years, consultant Cambridge Associates reports that private equity has returned roughly 13.6% a year compared to around 9% for the S&P over the same period. Cliffwater, another investment consultant specializing in alternatives, estimates that private loans are yielding slightly over 9% on average today. By comparison, the S&P US High Yield Corporate Bond Index closed trading on June 15th with a yield to maturity of just 4.5%.
Alternatives, like private equity, private credit and real assets, can be very attractive investment options, but at the same time, they come with a different set of risks than registered securities do. They are less liquid, more complex legally and structurally, and have a much wider dispersion of returns than traditional investments do.
Over the last twenty years, top-quartile equity mutual fund managers beat the equity benchmark, generating average returns of 10.3%, which is good, but top-quartile private equity managers posted annual returns of 22.5%. However, investors who chose bottom-quartile stock pickers wound up with returns of 7.7% – not great but not trailing the index that badly. On the other hand, bottom-quartile PE funds made just 2.7%. The upside to picking good managers in alternatives is much higher, but so is the downside of being stuck with a bad one.
I believe that such considerations require experience to successfully navigate. Through a disciplined approach to managing portfolios of alternative investments, which we call the 3 D’s, investors have a greater probability of achieving successful investment outcomes. These 3 D’s are Deal Sourcing, Due Diligence, and Diversification.
Sourcing investments from a broad and deep opportunity set provides a greater probability of finding the best. Too often, investors who jump in unprepared pay the price with very costly missteps. In fact, after meeting 3,500 alternatives shops in my career, I believe most of the value in selecting managers in alternatives comes from the ability to say no 3,400 times for every 100 times you say yes. That’s not something that can be replicated overnight, nor done after meeting 15 firms.
The experience of having picked through such a vast number of competitive offerings also gives important context around researching and selecting the ones likely to perform better. Having observed what works and what doesn’t work is perhaps the best way to acquire the knowledge required to build successful portfolios.
Institutional knowledge and experience and the selection of a trusted advisor with deep experience in these sectors can help build portfolios specifically designed to meet investment objectives. No investor needs hedge funds or private equity per se. The entire exercise is about curating the exposure to generate a desired return profile, capital appreciation or potentially a higher income than is possible via traditional markets, thanks to differentiated and less liquid risks.
Historically, many advisors simply divided the world into private equity, hedge funds, real assets, and private credit, and then set about to hire managers to fill those allocations. The results have often been disappointing, and this approach resulted in portfolios heavily weighted towards products that offered capacity and accessibility – ease of use in portfolio construction instead of best of breed.
As opposed to this more outdated, traditional approach of filling up alternative pie slices in a top-down asset allocation, the future of alternatives for individual investors instead lies in crafting portfolios of alternative investments uniquely cultivated to meet client needs for capital appreciation, income enhancement, and diversification.
This requires a fiduciary mindset, a disciplined approach to consistently scouring the market for opportunity wherever it can be found, and focusing on client outcomes. By leveraging our strengths in the 3 D’s, today Venturi is well positioned to ensure that the alternative investments we provide to our clients meet their specific investment objectives.
Cliffwater, “2021 Q1 Report on U.S. Direct Lending,” White Paper, May 2021
Schelling, Christopher, Better than Alpha: Three Steps to Capturing Excess Returns in a Changing World, McGraw-Hill, New York, NY, 2021
 Schelling (2021), pp. 82
 Cliffwater (2021), pp. 2
 Schelling (2021), pp. 98
The opinions expressed herein are intended solely as general market commentary and do not constitute investment advice nor is it an offer to sell securities. The third-party information used in this document has been obtained from various published and unpublished sources considered to be reliable. However, Venturi cannot guarantee its accuracy or completeness and thus does not accept liability for any direct or consequential losses arising from its use.
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