Private Equity May Be Right for Retired Clients

The need for alternatives exposure has never been greater, says a fintech exec who explains these asset classes.

By Rethinking65

Editor’s note: Rethinking65 recently asked Matt Brown, CEO of fintech platform CAIS, how older advisors can use alternative investments. CAIS brings alternative investing solutions and education to independent financial advisors and their clients.

Rethinking65: Our readers are advisors helping clients in the second half of life. Are people 50 and older using alternative investments as much as they should? Why or why not?

Matt Brown: This client demographic has rapidly grown in recent years and the need for alternatives exposure has never been greater. We cannot definitively say that “clients in the second half of life” are/are not using alternative investments as much as they should, but there is certainly an opportunity to increase allocations. Independent wealth managers have been historically under-allocated to alternatives (just 1% to 2% of clients’ portfolios) when compared with large national broker-dealers (approximately 15%) or institutional investors (approximately 30-40%), due to product complexity, higher minimums and fees, and the need for education, among other barriers to entry. As clients approach retirement, look to diversify their holdings, protect against inflation, and secure higher returns than available in fixed income or the stock market, alternative investments are a desirable and effective way to stay on track.

Rethinking65: We’d like to talk about the specific alt investments you offer: hedge funds, private equity, private real estate and private credit. Can you explain briefly what kinds of investments they include? What liquidity issues and costs should be considered, particularly by investors who are retired?

Brown: When it comes to liquidity issues, financial advisors have complete access to their investment timelines, and they can determine what fits best for their individual clients. Given the less liquid nature of these alternative investments, advisors need to consider the liquidity requirements of their clients, as well as their risk tolerance given the potential for the risk and return characteristics of these investments to differ from those of stocks and bonds over time. The four main categories of alternative investments — hedge funds, private equity, private debt and real estate — can potentially offer unique and varied yet complementary characteristics to more traditional investments such as stocks and bonds.

Private Equity

It may come as a surprise to some that in the first year of the pandemic, more applications for business formations were made than at any other time on record. Meanwhile, the number of public companies has shrunk to multi-decade lows.  In addition, companies are raising more capital rounds in the private markets, with more of the high growth phase of business formation going to those investors who invest in venture and growth equity segments of the private equity asset class. Given this, it may be increasingly important that investors allocate to private equity to seek to enhance the return of a traditional portfolio.

The potential for long-term value creation, active management, and proprietary deal sourcing are among some of the reasons why private equity funds have delivered 1% to 5% in excess annualized returns (net of all fees) over the S&P 500 since the global financial crisis.

Private Debt

Today, investors can access several benefits relative to traditional bonds by accessing private debt markets. First, investors may receive up to 8.8% yield on direct lending, the largest strategy within the private debt universe, compared to just 3.8% in U.S. high yield. Additionally, since 2008, direct lending has had a correlation of 0.0 to global bond markets, providing a diversification benefit relative to bonds and highlighting a potential source of funding for a move into private debt. Finally, and perhaps most important given the outlook for higher interest rates that many market participants are expecting, is the floating-rate structure typically associated with private debt.

To partially compensate for a higher risk of default, private lenders issue credit at spreads above a reference benchmark, which allows the contractual coupon to adjust over time as the benchmark adjusts. This typically leads to lower duration, or interest rate sensitivity, relative to traditional bonds, a potential benefit for investors in a rising rate environment.

Private Real Estate

The tangible nature of real estate makes it a very familiar investment for many investors, though its composition expands beyond single- and multi-family homes to include commercial and industrial real estate, to name a few. In addition to this, the focus on cash flows in the form of rents, as well as the potential for landlords to pass through rental increases, also make it a potential hedge against inflation. Year-over-year correlation between core U.S. real estate and headline inflation is just 0.46. Additionally, real estate has the potential to provide the diversification they are seeking in their traditional portfolios, as evidenced by the fact that U.S. Core Real Estate has 0.1 correlation to stocks, and -0.1 correlation to bonds, all while providing income with a 3.9% yield.

Hedge Funds

Hedge funds have the potential to provide effective diversification given their general focus on generating attractive risk-adjusted returns regardless of market directionality. Investor enthusiasm for hedge funds spiked last year and into this year given their relative and absolute performance through the pandemic, generating the strongest absolute return since 2009. Positive relative performance has continued into this year with hedge funds outperforming the S&P 500 Index in the third quarter, weathering September’s extreme volatility and protecting investors against the month’s significant drawdown. This, coupled with the events of the pandemic have placed the importance of risk management squarely in focus for investors who are increasingly looking to hedge funds to offset broader market risks.

Rethinking65: Thanks, Matt.

Latest news

Industry Snapshot Reveals Record Number of SEC-registered Investment Advisers

There were 15,396 SEC-registered advisers and 56.7 million asset management clients, according to the Investment Adviser Industry Snapshot

California Bans ‘Resort Fee’ and Other Hidden Charges

But other legislation would let restaurants charge a mandatory gratuity or other surcharge as long as it is displayed clearly on the menu.

Losing a Spouse Hits Most Women Hard Financially: Thrivent

Many widowed women had no financial conversations or plans in place before their spouse died, Thrivent's new survey finds.

Schwab Survey Finds Increased Opportunities for Advisors

Americans are most likely to seek financial guidance from an advisor, and three-quarters avoid social media influencers, the survey reveals.

The Sky’s the Limit for CEO Pay

Companies now must disclose how much CEO stock holdings increase when the market rises.

Advisors Boost Allocation to Private Markets as Client Interest Grows

Over half the investment advisors surveyed by Hamilton Lane plan to allocate 10%+ of clients’ portfolios to private markets this year.