You may be hearing more about Private Investments these days and wondering if they are suitable. The first question you may have is why the focus on them now?
With central banks around the world fighting re-emergent inflation, the 40-year cycle of lower interest rates has likely ended and moving forward we will see higher rates for longer. The impact has been that traditional portfolios with a bond and stock allocation have declined as valuations in both asset classes have fallen at the same time. In this environment investors are naturally seeking other forms of investments that are not correlated to traditional assets with the goal of increasing portfolio returns.
What are private investments? Simply put, these are investments that sit outside of public markets such as stocks, bonds and cash. Private investments typically include private equity, credit and real estate and are identified under the alternative investment category. The main attraction to these investments is that they can offer higher returns and that they can help diversify a portfolio to smooth out overall performance. They are particularly appealing when interest rates are low and public markets are fully priced, as has been the case for some time. The main consideration is that private investments require long holding periods typically more than five years and are considered illiquid relative to public offerings. Pension funds such as the Ontario Teachers Pension Plan are active in private investments because they need good returns to match obligations and their mandates are long term. For individuals, it makes most sense to look at private investments for retirement plans that have a long time horizon.
Private equity differs from venture capital in that it is primarily investments in mature companies. Strategic use of debt and management expertise is used to transform underperforming businesses. Private investments have drawn criticism for being ruthless strippers of corporate assets (the parts are worth more than the sum), this was the basis for the movie Wall Street. But modern private investors have countered stressing management expertise, ESG overlays and basically saving distressed companies.
Private credit is simply non-bank lending, mostly to mid-sized companies that are looking for more customized loans than the boiler-plate options provided by banks. And greater regulation has seen banks recede from the riskier corners of lending, leaving a funding gap for private lenders to step in. This gives investors exposure to a wider range of businesses and loans with higher interest rates and covenants to protect investor interests.
Private real estate investing gives investors access to actively managed portfolios of real estate without the upfront capital and on-going management hassles. Given the current housing shortage across North America, one area of real estate investing that has solid growth fundamentals is multi-residential investments. Demand for multi-residential properties is constant and is driven by land scarcity, demographics, population growth and the challenges of new home affordability. The main investment benefits are monthly income, capital appreciation and low volatility.
Private investments are typically packaged in Limited Partnerships (LPs) due to their longer holding periods and restrictions on withdrawals or available via Offering Memorandum (OM). In fact, mutual funds are restricted from holding private investments primarily because they are illiquid investments. Private equity ETFs are available, but they are limited to investing in publicly listed private equity companies, including business development companies and other financial institutions, or vehicles whose principal business is to invest in and lend capital to privately held companies. For this reason, Private investments are going to be most strongly considered by investors that have larger, mature portfolios that can commit large minimums ($100K+) for long periods (5Years+). Smaller portfolios can get some exposure through private equity ETFs.
Compared to public markets where information is readily available and regulated, private markets have much less information and it is up to investors to do their due diligence. For this reason, access to private investments is restricted to those who can take on the additional risk and accept longer holding periods. Private Investments are intended for use by accredited investors as defined in the Securities Act (Ontario) or National Instrument 45-106. Basically, you need to demonstrate your ability to take on the risk by having a baseline of net worth, net financial assets or gross income. For most that means a liquid portfolio size more than $1,000,000 net of liabilities and a family gross income over $300,000 annually.
Provided that the current environment of correlation and underperformance in traditional assets continues, the appetite for other options including private investments will only increase. To date, retail investors have largely not participated due to large initial deposits, long holding periods and a general lack of awareness and education aimed at this market. In short, the investment products have not been available. To address the gap between retail demand and product offerings it is reasonable to expect regulators to consult on the matter and press asset managers to offer retail product wrappers. It is also likely that accredited investor rules will be re-examined to lower the barriers of entry. For now, it makes good sense for interested investors to consult with their portfolio managers on the options available.
