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In recent years, market volatility has made it difficult for wealth managers to generate strong returns for their clients through traditional asset classes. As a result, they have turned their attention to alternative investments, notably private market funds. Indeed, in the decade to the end of 2022, private markets saw a 130% rise in global assets under management (AUM) to $22.6T.1
Given the current high inflation environment, and the trend of private companies staying private as they grow, we anticipate more investors to turn to private markets, not least to diversify but importantly to meet their growing expectations for higher portfolio returns.
Diversification beyond traditional asset classes and particularly into private markets is crucial for wealth managers to reduce risk and enhance portfolio resilience. This is because private market investments move differently to public markets – they have a lower correlation with each other compared to a portfolio of just public assets. When implemented within a well-managed portfolio, private market investments provide additional diversification benefits and help reduce the risk profile.
We have discussed in prior articles how private market returns have consistently outpaced those of public markets – whether that be over 5, 10 or 20-year periods. Achieving a long-term annualized portfolio return exceeding 10% has proven to be particularly tough with a portfolio comprising of only developed markets public securities. We expand on this below and highlight here the importance of private markets as a consideration for wealth managers, at a time when market volatility remains high.
Stock exchange listings, in the US,UK and across Europe have waned dramatically over recent years. Companies are thinking twice about going public, or at least delaying their IPO (Initial Public Offering). High interest rates, poor performances after IPO from many companies and low valuations have been key contributors. Businesses are finding that raising capital privately is increasingly viable and less expensive and time-consuming than opting for a public listing. As such, a wealth of innovative, growing and cash rich business have remained private.
Despite these factors and the growth of private markets mentioned above, wealth managers are still allocating a relatively small proportion of their portfolios to private market funds. Statistics vary, but most tend to be within 10-15%. That said, the Investment Association found in its 2021 survey that UK wealth managers allocate to private markets, on average, only 5% of their total AUM.2
The variance in the numbers can, at least in part, be attributed to different types of investors being able to access private markets. Institutional investors have, often exclusively, benefited from having access to private investment managers, whilst options for individual investors have been much more limited. Solutions available for Shariah-compliant investors have been even more scarce given the limitations on the use of leverage and interest-based returns.
The introduction of new financial technology (fintech) firms and investment fund platforms has been rapid. This, coupled with a continually unstable economic environment has seen both professional and HNW individual investors with specific investment goals, often within a younger demographic, increasingly utilizing alternative investment avenues to access such asset classes.
The benefits of expanding access to private markets have not escaped the knowledgeable wealth manager. But to do so would result in various, often complex, operational challenges.
Building a team with private market expertise is not easy and can require significant financial investment. It takes time for wealth managers to build their experience, reputation and industry connections. Without it, a lack of awareness and education about the opportunities presented by private markets can lead to poor investment decisions.
Moreover, navigating the complexities and regulatory hurdles associated with private markets poses additional barriers in the form of distribution, reporting and compliance. Does the team have enough resources to perform full due diligence on companies and fund managers? Without the right know-how, wealth managers will not be able to deal with private markets in the most tax efficient way.
Given its long-term investment horizons, it is true that private market investing is less liquid than public market investing. The perceived need for liquidity tends to deter some wealth managers from exploring private market investments. But with many fundamental wealth managers investing over long-periods, liquidity concerns may be overdone. Forgoing private markets for this reason means sacrificing the potential for higher returns.
Until recently, regulation has prevented retail investors from investing directly in private markets. Now, a softening of regulatory rules has enabled retail investors to access such asset classes, if they can show that they have the capacity to take on such risk, such as HNW individuals with sufficient knowledge and expertise. In addition, the financial entry point has always been beyond reach for most individuals, but such thresholds are being lowered mainly due to the emergence of investment platforms pooling capital to reach the minimums expected by private market fund managers.
Despite the challenges, there are compelling reasons for wealth managers and investors to explore adding private market funds to their portfolios.
Private markets offer the potential for higher returns, particularly when compared to public markets. Private markets have historically outperformed public markets and with structures more in line with Shariah values, the alternative is clear for investors searching for higher yield.
Regardless of which long-term period is considered, private equities have performed strongly relative to public benchmarks.
In addition, top-ranked private equity funds have at least doubled their investment value over prior periods, which is encouraging for growth investors. Income investors can also find funds where target annual returns are in excess of 7% - highly reasonable in today’s tough market conditions.
Private markets also provide access to unique investment opportunities and asset classes, including early-stage ventures and emerging industries. As growth in private market assets accelerates, the opportunity to gain exposure to companies at the earlier stages of growth increases. Even now, only a fraction, less than 1% of US companies are traded on public markets.
Furthermore, for wealth managers catering to Shariah-compliant clients, and aside from the fact that the public alternatives are extremely limited, investing in private markets aligns with long-term perspectives and fosters economic growth and recovery, which is in line with Shariah values.
As technology has developed and disrupted the investment space, notably with the introduction of robo-advisors, the wealth manager proposition of offering model public market portfolios is no longer sufficiently differentiated. Adding private market funds would once again set wealth managers apart. By helping investors to navigate private markets, clients would receive a level of added value that would be difficult to replicate, especially digitally.
Advancements in financial technologies are playing a crucial role in democratizing access to private market investments. Lack of liquidity and high capital requirements have been the most significant barriers preventing retail investors from gaining access to private markets. Now, fintech platforms and digital investment solutions have streamlined processes for due diligence, investment selection, distribution and portfolio monitoring. They have also expanded investor outreach and engagement through online channels.
The integration of data analytics and artificial intelligence (AI) is also optimizing decision-making processes, enhancing the efficiency and effectiveness of private market investments.
At Mnaara, we’ve noticed the significant rise in demand from individuals seeking to invest in private markets. As such, we are leveraging technology to provide access to top-performing private market funds, thus bridging the gap between Shariah-conscious investors and the opportunity for higher returns.
Wealth managers must overcome the aforementioned barriers and embrace the opportunities presented by private market investments. While incorporating technology into their business systems may present challenges, it is essential for wealth managers to understand the transformative role that technology can play in facilitating investors with access to private investments.
Investors, too, should explore the untapped potential of private markets for long-term wealth creation and the role it can play in generating economic prosperity. By leveraging technology and embracing alternative investment avenues, wealth managers can expand their client base as demand from individuals grows, whilst delivering additional value to their clients in an evolving investment landscape.
Author
Saad Adada, CFA
Sources:
1 https://www.ey.com/en_gl/private-business/are-you-harnessing-the-growth-and-resilience-of-private-capital#:~:text=In%20the%20past%20decade%2C%20private,by%20the%20end%20of%202022
2 https://www.theia.org/sites/default/files/2021-12/IA_Goji_WhitePaper_PrivateAssetsinWealthPortfolios_Dec2021.pdf
Important Disclosures
The information contained in this material has not been independently verified and no representation or warranty expressed or implied is made as to, and no reliance should be placed on, the fairness, accuracy, completeness or correctness of this information or opinions contained herein. The views, opinions and estimates expressed herein constitute personal judgments. Any performance data or information shared should not be seen as an indicator or guarantee of future performance. This does not constitute an offer or invitation to purchase or subscribe for any security. Mnaara does not offer any investment advice and nothing in this material constitutes advice or a personal recommendation. Private market investments are only available to qualified investors.
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