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Last year was tough for capital markets. A portfolio invested in stocks and bonds returned negative double-digit returns, while uncertainties rose around the globe. High inflation, higher rates, lower economic growth, and geopolitical tensions marked 2022 as a uniquely painful year.
But investments in a selection of private markets – also known as “alternatives” – reduced the volatility of portfolios. These investments are key in helping diversify risks while generating positive returns in different market scenarios.
But what exactly are alternative investments?
Alternative investments are private, non-publicly traded funds across different asset classes. These funds specialize in real estate, private credit, private equity, etc. Access to these funds allows investors to own long-term investments that create value in different industries. Within each of those asset classes, there are different fund profiles, hence different returns and investment terms. The key difference between a private and a publicly traded fund is liquidity. These funds primarily have less liquidity, allowing investors to only sell their participation on a monthly basis and are sometimes locked up for numerous years. They can also require higher investment minimums.
The main sectors
Private real estate
Private real estate investments involve the acquisition, development, or management of commercial or residential real estate properties. These funds seek to generate attractive returns through a variety of strategies.
One is core investing, which is more conservative, where investors focus on stable, income-generating properties. The investment strategy and holding period varies widely depending on the specific investment vehicle and the goals of the fund. These funds are usually integrated as private real estate income trusts (private REITs).
Opportunistic investing seeks to take advantage of market inefficiencies or distressed assets. These funds encompass value-add investing, where they identify properties that are undervalued or underperforming and look to increase their value through renovations or other improvements.
Private credit
Private-credit debt is issued by private lenders to non-public companies that are unable to obtain financing from traditional banks or other public sources.
These funds rose in popularity after the 2008 financial crisis due to regulatory changes that made it more difficult for traditional banks to lend to small and mid-sized businesses. The financial crisis led to increased scrutiny of banks and their lending practices. This created a funding gap for these companies, which needed capital to grow and expand their operations.
Private-credit investments offer several advantages over public debt investments. Private credit investors may negotiate more favorable terms, such as higher interest rates, floating interest rates, and a collateralized position within the capital structure of the company. These investments offer greater diversification than public debt investments, as they may be less correlated with public markets.
Private equity
Private-equity funds use the capital they raise to acquire a controlling stake in companies or to provide growth capital to help them expand. These funds are led by professional investment managers, who are responsible for sourcing investment opportunities, conducting due diligence, and managing the portfolio of companies in which the fund invests. Private-equity managers typically have a long-term investment horizon and aim to create value for their investors by improving the operational and financial performance of the companies in which they invest.
Private-equity funds take a variety of investment strategies, including venture capital, growth equity, and buyout investments. Venture-capital funds typically invest in early-stage companies with high-growth potential, while growth-equity funds invest in more established companies that are seeking capital to expand their operations. Buyout funds typically invest in mature companies with stable cash flows, with the aim of improving their operations and financial performance to generate attractive returns.
Alternative investments fill a latent need
Private investments have for a long time been pursued within the domain of large institutional investors, such as pension funds or sovereign wealth funds, mainly due to their historically higher minimums of investment, as well as their higher expected returns. However, several years ago, my firm determined that these funds fulfilled a latent need within our roster of ultra-high-net-worth (UHNW) investor clients. A close examination of market tendencies and manager skill sets brought us to the realization that these investments were suitable for many UHNW investors. We embarked on a thorough due-diligence effort while focusing on a selection of top-tier managers for our lineup of alternative investments. Today, in addition to seeking funds that maintain high levels of supervisory and regulatory scrutiny, we have partnered with fund managers that have excellent reputations. Over their long track records, these managers have delivered the consistent returns and substantial expertise that we covet for our clients*.
Private markets have outpaced public markets in the last 20 years. Clear evidence shows that the number of public companies or stocks have halved since the year 2000. There are almost five times more private companies when compared to public ones. This tendency is growing and translates to a fertile world of opportunities outside of the public markets.
*Disclaimer: Past performance is not indicative of future performance.
Nestor Hernandez is a portfolio manager at Intercontinental Wealth Advisors, an award-winning, independent RIA firm known for crafting custom-tailored financial strategies that address their clients’ unique wealth preservation needs and multinational interests. Originally from Torreon, Mexico, Nestor joined Intercontinental’s investment committee in 2015 after receiving his B.B.A in finance from the University of Texas at San Antonio.
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Advisor Perspectives welcomes guest contributions. The views presented here do not necessarily represent those of Advisor Perspectives.
