Investing in private markets (aka “alternatives”), once the exclusive terrain navigated by institutional investors and ultra-high-net-worth individuals, has seen a notable shift in recent years.  Today’s financial topography reveals that the allure of private markets – asset classes like private equity, private credit, private real estate, and private infrastructure – is stronger than ever.  The inclusion of these alternative asset classes provides low correlations relative to traditional asset classes, like equities and fixed income, allowing you to potentially achieve a target return without taking unnecessary risks – thus, “lifting the efficient frontier,” a phrase denoting the optimal portfolio return for a given level of risk.  

When incorporating alternatives in portfolios, it is paramount that one distinguishes between “return enhancers” (i.e., private equity, venture capital, and hedge funds) and “diversifiers” (i.e., private real estate and infrastructure).  The distinction is key as one will want to consider asset location, or what “type” of account is most suitable to achieve the desired client outcome.  For example, in the current environment, a private credit strategy that may produce ~10% in ordinary income over a year would be best sheltered in an IRA.  Alternatively, a growth-focused private equity strategy may be more appropriate for a taxable account or a Roth IRA.  Let’s dig a little deeper into the primary types of private market investments…

Private Equity: The Crown Jewel

Private equity (PE) sits at the heart of private markets, boasting robust growth that easily outpaces traditional public equities.  Within PE, investors pour capital into private companies, often to scale operations, launch new products, or improve governance and key initiatives.  This discipline captures the imagination of high-net-worth individuals who seek to leverage their investments to secure a stake in the next game-changing startup or support a well-established company poised for expansion.  Within the private equity sphere, secondary investments have also regained popularity after 2022 saw a major valuation reset and liquidity became scarce.  When an investor in a private equity fund needs liquidity, they can offer their stake on the secondary market, often at a discount, which allows the new holder to benefit from the valuation markup.  This is just the tip of the iceberg in terms of the subset of opportunities within the PE universe.

Private Credit: The Emergent Force

With banks retreating from lending to smaller or riskier enterprises, the void has been filled by private credit.  It is important to understand that there are many types of private credit strategies, including direct loans made to companies seeking growth capital or refinancing options, asset-backed arrangements, or structured financing to name a few.  These typically come with higher yields than traditional fixed-income securities, insulating the investor from interest rate volatility – a persuasive attraction for astute investors seeking income stability.  With respect to direct lending, the big players in this space often seek a first-lien senior-secured position within the capital structure along with tight covenants to protect their investors in case of defaults.

Real Assets: Private Real Estate and Infrastructure

Concrete assets, quite literally, reside within the realms of private real estate and infrastructure.  Investors are drawn to these assets for their potential to diversify portfolios and offer attractive returns.  Whether it’s an investment in a burgeoning urban development project or involvement in the overhaul of crucial infrastructure such as roads, airports, utilities, and data centers, to name a few – these physical investments often boast long-term stability and resilience against inflation.  Beyond serving as an inflation hedge, these strategies can generate steady income for investors.  Within real estate, specifically, some or all the income may be tax-deferred given the ability to characterize ordinary income as Return of Capital (“ROC”).  However, the deferral is subject to recapture and should be considered for tax planning purposes.  Always check with your CPA for tax-related questions.

Lifting the Efficient Frontier and Lowering Barriers to Entry

The allure of investing is not just about achieving returns; it’s about optimizing returns and the risk-reward ratio.  Here, private markets are particularly pivotal.  By operating beyond the public markets, these investments may reduce portfolio volatility while possibly elevating returns, hence the phrase, “lifting the efficient frontier.”  Dr. Harry Markowitz, the father of Modern Portfolio Theory, pioneered this concept in the 1950s and won a Nobel prize in economics for it in the 1990s.

Incorporating private market assets into a portfolio diversifies investment streams and may cushion against the gyrations of public markets.  Importantly, however, these benefits are not without their tradeoffs as private market investments historically have demanded a higher threshold for entry, longer lock-up periods, and a different risk assessment than their public counterparts.  In addition, alternative investments are often subject to gates (as observed over the past two years within private real estate), which limit investor redemptions to protect the fund and its long-term investors.  As a result, we must highlight that alternatives have less liquidity and therefore expectations for cash needs must be managed carefully.

In recent years, we have seen more “investor friendly” vehicles for alternatives emerge in the marketplace.  These are often referred to as “evergreen” or “perpetual” offerings as they do not require capital calls but rather invest your entire commitment immediately alongside other participants.  This “evergreen” approach is a key benefit as it allows for immediate access to current fund holdings and helps minimize the “j-curve” effect prevalent in more traditional private investment offerings.  Beyond that, these strategies offer the potential for lower minimums, shorter or no lock-up periods, monthly availability, and quarterly liquidity.  While the additional access is a positive for many accredited investors, the gates and illiquidity premiums must still be considered.  Having an expert on your side to help navigate these important details is paramount.

Conclusion

For qualified investors eyeing a sophisticated investment strategy to help complement their traditional investment portfolio, the private markets represent an arena brimming with potential.  These investment classes offer the enticing prospect of not just asset growth but also portfolio optimization.  With trends like private equity, private credit, real estate, and infrastructure development at the forefront, the private markets continue to evolve, promising new opportunities for discerning investors ready to harness their potential.

Having said that, private markets investing isn’t without its challenges, including due diligence intricacies, opaque pricing mechanisms, and illiquidity.  At TritonPoint Wealth, it is of the utmost importance that we uphold the fiduciary standard and, as such, every facet of a client’s unique situation must be thoroughly examined before incorporating private market strategies.  

You. First. Always.

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