Private assets: routes in for investors

Much has been written about the democratisation of private assets; the catch-all term for a range of changes expanding private market access beyond its traditional, institutional client base. However, the case could be made that discussions of democratisation as a theme have not been framed quite the right way, leading to some confusion for some investors.

Much of what has been written on democratisation depicts it as a dawning revolution. I see it as more of an evolution. Smaller investors have had access to private assets via investment trusts for decades. Options have however, multiplied in recent years, and they will continue to do so.

As a firm believer than many clients could benefit from an allocation to private assets, it remains the case that the suitability of that allocation is paramount. Democratisation simply means that access is becoming less of a challenge.

What are the different options to access private assets?

The below is a rudimentary illustration of the key structures available to invest in private assets today. Each structure has its own liquidity profile, and accordingly varies by the nature of investments within, as well as fees and minimum investments. This is illustrative only and should not be viewed as investment advice or a recommendation to buy or sell.

Listed, closed ended

As mentioned, listed, closed ended (or investment trust) private asset vehicles have existed for a long time, with a claim to the title of first “democratised” options. Developments, however, have modernised the structures and helped address some of the issues the structure can present.

Liquidity for traditional investment trusts (ITs) in normal market conditions is good, with intra-day trading available. This liquidity profile is what has traditionally driven their potential suitability for more retail or “mass affluent” investors.

In traditional ITs the share price can move independently of the stated net asset value (NAV). Investors may face a situation, if selling, where the share price is at a (potentially significant) discount to NAV. Many investors favour the IT structure for exactly this reason, attracted to the potential to take advantage of a dislocation between the trading price and intrinsic value, but it must be factored in when making the decision to invest in these assets.

Obtaining liquidity has caused some issues in the past, with isolated instances of adverse market environments compromising the ability of sellers to find a willing buyer on the other side. This should be managed, in our view, by appropriate portfolio construction and due regard to individual client’s circumstances, such a time horizon, risk appetite and need for liquid access to their capital. But this is also where the important developments mentioned earlier have been made.

Feeder funds

Technology has been instrumental in the growth of no-liquidity, or periodic liquidity, feeder funds available through web platforms. These new closed ended fund structures are designed specifically for private investors, by having a structured capital call schedule, a shorter fund term than more institutional orientated funds and lower minimum subscriptions amounts.

Semi-liquid

Semi-liquid options are the fund structures soaking up much of the democratisation limelight just now, because many of the most significant product developments have been in this space.

Where semi-liquid funds take the baton from listed vehicles is on the subscription amounts. These funds often have no minimum subscription amounts when invested in through a professional adviser. Subscriptions and redemptions are at the fund’s net asset value (NAV). This removes the volatility or market beta compared to closed ended funds, which rely on a secondary market for liquidity where the price you receive is at the mercy of supply / demand dynamics.

This also means liquidity is not as high as it is for listed closed ended options, as the funds have the ability to “gate” when certain thresholds are breached. For those clients more interested in the semi-liquid structure – they are typically more concerned over illiquidity and have smaller capital sums to deploy. A clear assessment of a funds mechanics to provide liquidity is crucial to any wealth manager allocating clients capital to this fund structure.

Fund of fund solutions

Whilst fund of fund solutions have to some extent fallen out of favour, they are still a relevant means for private investors to develop well-diversified exposure to private assets.

Minimum amounts vary according to regulatory status. As they are typically closed-ended funds, the investor has to forego flexibility of the listed vehicles. Due to their nature, the capital deployment can often take longer, with an investment period of up to five years.

Both fund of funds and semi-liquid funds may have an allocation to venture capital, as well as small and medium-sized, and some large buyouts. Very large investors can struggle to access smaller companies, perhaps due to internal risk controls, but fund of funds can “scale down” their investors. Conversely, smaller investors can “scale up” to access more and larger funds than they otherwise could.

While diversification in fund of funds is naturally higher so too are ‘all in’ costs. Where we have seen more interest from clients in the fund of fund space is for those investors who are happy and able to tie up their capital for longer periods of time and who want broad diversified exposure to private assets.

Single fund investment

The final fund structure option selective clients have to access private assets is single fund investments. Here minimum subscription amounts are higher than elsewhere, although they have been coming down in recent years.

However, liquidity profiles often are very different. We would typically propose these types of private asset investments only where an investor could handle an investment term of over ten years. The life of the fund will often comprise an investment phase and a “harvesting” or distribution period. To some investors this may sound like a long time to lock up capital. However, we have seen countless examples over the years of clients maintaining liquidity profiles in larger portfolios that they do not need.

Another risk consideration in single funds is that diversification is lower than fund of funds and semi-liquid vehicles. However, the benefit that comes with this is that overall fees tend to be lower. We have found our larger, more sophisticated clients express the most interest in these types of funds, and are happy to take on more concentration risk in the hope of achieving higher rates of investment returns.

Why incorporate private assets at all?

Some of the comments made earlier in this article may put off some investors from allocating to private assets. Indeed, market conditions at the time of writing have certainly created an air of caution.

Even so, I believe that an allocation to private assets, as part of a multi-asset strategy, can bring improved risk return dynamics to a portfolio.

There are three key reasons for this:

1. The opportunity set – investing in private markets enables clients to access an opportunity set that is not available in public markets. Recent data from Hamilton Lane highlights that

The evidence also shows that companies are staying private for longer or indeed not choosing to list at all. By not allocating to this asset class there is a huge investable universe that you are missing out.

1. Enhanced returns – there is strong historic evidence to show that private markets have generated premium returns to public markets on a net of fees basis. This is driven by the illiquidity and complexity premiums found in the asset class. While past performance is no guide to future returns, we believe the depth of the market and manager skill will continue to drive this trend looking forward.
2. Diversification benefits – Data suggests that an allocation to private assets improves diversification across risk profiles. Private asset valuations are only updated infrequently and are not often “marked to market,” that is, priced to reflect movements in public markets.

Both features dampen reported volatility. It is reasonable to expect that the pattern of returns from a portfolio of private market investments will look different from the returns of equity or bond markets. This is especially true if the portfolio is diversified across subsectors and vintages within private markets.