While equities have historically been the bedrock of investment portfolios, and continue to be so, seeking out new opportunities is becoming ever more attractive, especially among the wealthy.
Indeed, family offices now have 46% of their total portfolio in alternative investments, according to the latest JPMorgan Private Bank Global Family Office Report.
The allure of alternative investments lies in their ability to provide diversification benefits that go beyond what the stock market alone can offer.
While equities are subject to market volatility and economic fluctuations, alternative assets often exhibit low correlation with traditional financial markets, making them valuable additions to a well-rounded investment portfolio.
This allocation of capital across a diverse range of asset classes, allows investors to reduce overall portfolio risk and enhance potential returns.
Among the most popular alternative investments is private equity (PE).
The appeal lies in its potential for significant returns, often outperforming public markets over the long term. This is particularly attractive in an environment where traditional equities may offer lower expected returns due to high valuations and market uncertainties.
One of the key advantages is the ability to tap into growth opportunities that are not accessible through public markets.
Private equity firms invest in private companies, often providing capital for growth, restructuring, or buyouts. This involvement can lead to substantial value creation through strategic management, operational improvements, and innovation. Investors can therefore benefit from the growth and profitability of these companies as they mature and potentially go public or are sold at a premium.
In addition, PE investments can provide attractive returns through active management and a longer investment horizon.
Unlike public market investments, which are subject to daily price fluctuations, private equity investments are typically held for several years. This long-term perspective allows managers to implement strategic changes and improvements without the pressure of short-term market reactions. As a result, investors can achieve higher returns by focusing on the underlying value creation in their portfolio companies.
However, investing in private equity also comes with its own set of challenges.
One of the primary concerns is the illiquid nature of these investments. Unlike equities, which can be bought and sold easily, private equity investments are not readily tradable.
This lack of liquidity means that investors may have to wait several years to realise their returns, making private equity a less suitable option for those with short-term liquidity needs.
Another challenge is the high level of risk associated with private equity investments. While the potential for high returns is attractive, it comes with the possibility of significant losses.
Private companies can be more volatile and less predictable than their public counterparts, and the success of investments often depends on the ability of the management team to execute their strategy effectively. Additionally, private equity investments typically require substantial capital commitments, which can be a barrier for smaller investors.
Deal-making in the space also faces its own set of issues. The competitive nature of the market means that finding attractive investment opportunities can be difficult. Private equity firms often compete with each other, as well as with other types of investors, for the best deals.
This competition can drive up valuations and make it harder to achieve the desired returns; and conducting due diligence on private companies can be complex and time-consuming, requiring significant resources and expertise.
Despite these challenges, the advantages of private equity continue to attract investors. One notable trend is the increasing interest in specific sectors and industries that are expected to experience significant growth.
For example, tech, healthcare, and renewable energy are areas where private equity investments have been particularly active over the last few years. These sectors offer opportunities for innovation and disruption, which can lead to substantial value creation.
Additionally, the rise of impact investing has also influenced the private equity landscape. Investors are increasingly looking to align their investments with their values, seeking opportunities that not only provide financial returns but also generate a positive social or environmental impact.
Private equity firms are responding to this demand by incorporating environmental, social, and governance (ESG) criteria into their investment strategies, thereby attracting a broader range of investors.
Elsewhere, ETFs (Exchange-Traded Funds) – which haven’t been out of the headlines all year, it seems – combine the diversification benefits of mutual funds with the flexibility and liquidity of individual stocks, offering investors exposure to a diverse range of asset classes and investment strategies.
The low expense ratios and intraday liquidity provide a cost-effective and convenient way to invest in various market segments, from equities and bonds to commodities and currencies.
High net worth individuals are also increasingly seeking venture capital investments involving financing early-stage companies with high growth potential in exchange for equity ownership.
Of course, this is inherently risky, but offers the opportunity to participate in the innovation and disruption shaping the future economy. Successful venture investments can deliver exponential returns, making them attractive for investors seeking high-growth opportunities outside the stock market.
Another vehicle being considered more and more by those looking beyond traditional products are fixed income solutions which encompass a range of debt securities such as bonds, treasury bills, and corporate loans, offering investors predictable returns and income streams.
With an increasingly diverse range of fixed income products available, investors can tailor their fixed income allocations to meet specific risk preferences and investment objectives.
I fully expect that as the world becomes more and more digitalised – and the so-called Fourth Industrial Revolution – fully takes hold, this trend of seeking out alternative investments, which typically disrupt and innovate sectors, will continue to grow exponentially.
That said, there will always be a place in investment portfolios for traditional assets such as stocks and bonds.
Nigel Green is deVere CEO and Founder
Also published on Medium.
