Private assets: why and how?
Private assets: why and how?
Last year, private equity firms spent almost £30 billion taking UK companies private1 – almost twice the £17 billion raised in UK IPOs.2
Both 'take-privates' and IPOs have slowed this year. But the figures highlight a trend that can be observed in developed markets around the world: a shift in activity and capital towards private markets. They are also an indication of the huge resources that the private equity industry now commands.
Private equity is a key constituent of the 'private asset' universe – but it is far from the only one. Investors are now also turning to private vehicles to access opportunities in credit and lending, infrastructure and property. Traditionally, these markets have been the preserve of professional investors, including sovereign wealth funds, pension funds and family offices. However, things are changing and today there are many more ways for high net worth investors to access these markets.
The trend has been referred to as a 'democratisation'. It is often described as a revolution – but in reality it is more of an evolution. Smaller investors have had access to private assets through listed investment trusts for decades. However, options have multiplied in recent years and they will continue to do so.
I strongly believe that many clients could benefit from an allocation to private assets. However, it remains the case that the suitability of that allocation is paramount; tying up capital for the long term may not be appropriate for everyone, even those with significant wealth. Democratisation simply means that access is becoming less of a challenge.
Why incorporate private assets?
An allocation to private assets, as part of a multi-asset strategy, can improve the risk/return dynamics of a portfolio. There are three key reasons for this:
- The opportunity set
Investing in private markets enables clients to access an opportunity set that is not available in public markets. Recent data from private equity fund manager Hamilton Lane highlights that 87% of US companies with more than $100 million in revenue are in private hands. The data also shows that many companies are staying private for longer before pursuing a public market listing - or not going public at all. By not allocating to private markets, you are potentially missing out on a huge investable universe.
- Enhanced returns
There is strong historic evidence to show that private markets have generated higher returns than public markets, even after taking fees into account. This additional return can be thought of as compensation for the reduced liquidity, and potentially also the complexity, of private market investments. 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 in the future.
- Diversification benefits
Data suggests that an allocation to private assets improves diversification across risk profiles. It is reasonable to expect that the pattern of returns from a portfolio of private market investments will look different from the returns of listed equity or bond markets. This is especially true if the portfolio is diversified across subsectors and vintages within private markets. Furthermore, private asset valuations are not repriced on a daily basis like publicly-traded investments. While private assets are impacted by the same economic forces as listed assets, they may not be subject to the dramatic swings in valuation observed in volatile public markets. Both features can dampen reported volatility.
What are the different options to access private assets?
Below, we look at the key structures available to invest in private assets today. Each structure has its own liquidity profile and differ in terms of the kinds of investments they can hold as well as fee structures and minimum investments. This is illustrative only and should not be viewed as investment advice or a recommendation to buy or sell.
Listed investment trusts
Investment trusts focused on private assets have existed for a long time. In normal market conditions, liquidity for traditional investment trusts is good, with intra-day trading available. This liquidity profile is what has traditionally driven their potential suitability for retail and “mass affluent” investors.
An investment trust’s share price moves independently of the reported net asset value (NAV). Many investors favour investment trusts 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. Investors looking to sell may face a situation where the share price is at a (potentially significant) discount to NAV.
This has caused issues in the past, with some examples 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.
Semi-liquid options are the fund structures soaking up much of the democratisation limelight just now and it is where the most significant product developments have been taking place. Semi-liquid vehicles typically allow for monthly subscriptions and quarterly redemptions. However, redemptions are often limited to a proportion of the fund and may be gated in certain market conditions, such as during periods of volatility. This liquidity is therefore not guaranteed.
Subscriptions and redemptions take place at the fund’s NAV. This removes the volatility observed with listed investment trusts, which rely on a secondary market for liquidity. As mentioned earlier, the price you pay or receive may not be the same as the NAV and is at the mercy of supply / demand dynamics.
These funds often have no minimum subscription amounts when investments are made through a professional adviser.
Fund of funds
Fund of fund solutions can be a useful way for private investors to gain diversified exposure to private assets.
They allow clients to access private assets with relatively low minimum investment amounts and simplified administration. This solution does however carry higher costs due to the layering of fees and resulting portfolios are often highly diversified which may limit the return potential. Investors in these structures forego the flexibility of listed vehicles, meaning they must be prepared to commit capital for the long term.
Single fund investment
Some clients may have the option to access private assets though single funds. Minimum subscription amounts are higher than for other structures, although they have been coming down in recent years.
This allows for the construction of a bespoke portfolio targeting specialist managers operating in attractive market segments. These more concentrated investments are riskier than a more diversified fund of funds but may also offer higher returns.
These investments are generally illiquid and only suitable where an investor can handle an investment term of over ten years. 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.
In general, our allocation to private assets is spread across illiquid, semi-liquid and liquid vehicles. However, our allocations to private assets tend to be highly customised and depend on clients’ risk appetite and liquidity requirements.
We advise that allocations to private assets should be diversified and built up systemically over a period of time. In the early years, committed capital is invested in private assets before distributions are made from the invested funds, typically after 5–7 years. These distributions can then either be used to fund new investments or capital drawdown in the later years of the programme, providing a smoother cash flow profile.
At Cazenove Capital we adopt an open architecture approach to investing in private markets. This allows us to complement our access to the internal strategic capabilities of the Schroders Group with relationships with an industry network of specialist third-party providers.
Don’t invest unless you’re prepared to lose all the money you invest. This is a high-risk investment and you are unlikely to be protected if something goes wrong.
Private Assets investment risk: Past performance is not a guide to future performance. The value of an investment and the income from it may go down as well as up and investors may not get back the amount originally invested. Investors should only invest in private assets (and other similar illiquid and high risk assets) if they are prepared and have the ability to sustain a total loss of their investment.
The success of these funds is dependent in part on the skill and performance of the investment professionals managing the underlying assets. No representation has been or can be made as to the future performance of the funds. The value of the funds’ assets may be affected by uncertainties such as political developments, changes in law, tax, currency fluctuations and other developments in the countries in which investments may be made. Whilst investment in the funds can offer the potential of higher than average returns, it also involves a corresponding higher degree of risk and is only considered appropriate for investors who can afford to take that risk. Investors must be capable of evaluating such merits and risks.
Illiquidity: Private Assets are more illiquid than other types of fund. Shareholders may well not be able to realise their investment prior to the relevant exit dates. Any secondary market tends to be very limited. Although the shares may be listed on a stock exchange, the expectation is for very limited liquidity and minimal trading activity. An investment in the funds is therefore illiquid when compared to exchange traded equities.
This article is issued by Cazenove Capital which is part of the Schroder Group and a trading name of Schroder & Co. Limited, 1 London Wall Place, London EC2Y 5AU. Authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. Nothing in this document should be deemed to constitute the provision of financial, investment or other professional advice in any way. Past performance is not a guide to future performance. The value of an investment and the income from it may go down as well as up and investors may not get back the amount originally invested. This document may include forward-looking statements that are based upon our current opinions, expectations and projections. We undertake no obligation to update or revise any forward-looking statements. Actual results could differ materially from those anticipated in the forward-looking statements. All data contained within this document is sourced from Cazenove Capital unless otherwise stated.