Alternative investments, those often-illiquid private funds offered previously only to institutions and ultra-high-net-worth family offices, have evolved. Whether in the pursuit of alpha, enhanced beta or the hunt for higher income streams, well-chosen alternative investments can now help individual investors build diversified portfolios that achieve their wealth objectives.
In February 2021, KKR surveyed UHNW family CIOs and found that families with $1 billion or more in assets under management allocated 51%-54% to alternatives. Families under $1 billion had 44%. Mass affluent investors are estimated to allocate less than 5% to alternatives.
Advisors for the wealthiest families invest substantially in alternatives to achieve their client’s goals for wealth accumulation and preservation. Allocations to top funds can outperform comparable public benchmarks. They can also offer valuable diversification and attractive exposure to thematic investments.
Many of the best-known asset managers have made new alternative strategies available to individual investors across asset classes such as private equity, real estate and private credit. With innovations in alternatives’ design and delivery improving the investor experience, financial advisors may want to take a fresh look at what has long been a go-to asset class for large institutions and family offices.
More Than Just Private Equity
Alternatives provide access to a large and growing universe of private companies, spanning fast-growth startups to household names in technology, media, healthcare and consumer products. In the U.S. alone, private companies with more than $100 million in annual revenue are six times more numerous than public companies with similar revenues. Many growth companies now choose to remain private because of ample access to long-term growth capital.
Private equity managers can curate a portfolio of investments that capture specific growth trends, such as technology adoption and demographic shifts. They can also deliver resources that help a company expand internationally, provide a network of potential new customers or expand through additional acquisitions. This active ownership can drive alpha for companies and investors, making private equity funds a potentially attractive proposition for those looking to compound capital.
However, alternative investments encompass much more than just private equity. Private credit and real assets also offer active management and potential for attractive exposure to yielding assets, which may have lower correlations to economic cycles and public indices.
Leveraged and private credit investments have grown from $235 billion in 2008 to $750 billion in 2019. Strategies target ownership of higher-yielding corporate debt and asset-backed financing. Unlike buying a bond on the secondary market, active managers can negotiate terms and pricing directly with issuers and build nimbler, conviction-based portfolios.
Quarterly liquid alternative credit funds facilitate access to privately negotiated credit that can drive incremental value. When market volatility jumps – as it did in 2020 – alternative credit managers are not forced to sell at steep discounts to meet redemption calls; instead, they can use their more patient capital to buy opportunistically.
Income-oriented private real estate (the third largest asset class behind stocks and bonds) has historically generated attractive risk-adjusted cash yields. With higher inflation looming, assets such as multifamily housing can serve as a hedge because rents reset annually. Investment in strategically located industrial warehouses can combine the benefits of hard assets and rising rents with a thematic bet on e-commerce. New real estate funds are make investing in institutional quality commercial real estate more accessible than ever.
Education Is Key
New fund structures approved by regulators bring the investor experience in alternatives closer to that of a mutual fund. These innovations are driving increased accessibility, including structures that facilitate easier subscriptions, periodic liquidity through redemption programs and streamlined tax reporting.
Advisors must understand the needs of their clients and ask the right questions when evaluating products that invest in illiquid investments. They should understand a fund’s liquidity profile and how it can meet repurchases. Understanding how and why a fund uses leverage is also important. Utilized appropriately, leverage can support attractive risk-adjusted returns and enable funds to remain fully invested while facilitating repurchases and new inflows.
Asset managers and wealth platforms play an important role in educating advisors on their approaches to portfolio construction to maintain consistent exposure to the alternative asset class and provide adequate liquidity.
New approaches seek to manage the private equity “J curve,” with low early returns that later swoop upward, typically occurring from the lag between when investments are made and gains realized. Semi-liquid private equity fund structures allow investors to buy into the existing portfolio at current valuations, gaining exposure to investments that may be closer to realizing gains.
To put new capital to work, fund managers may target co-investments in individual deals alongside sponsors to mitigate cash drag. Funds that have reached critical scale with good access to credit facilities may be positioned to deliver a smother experience for individual investors.
Building relationships with individual investors requires meaningful commitments to investor education and transparency. Asset managers should work alongside their financial advisor partners to better educate individual investor clients so they can choose the optimal alternative solutions for their portfolios and manage necessary liquidity considerations.
Alternative investments can create meaningful opportunities for individual investors to grow their wealth and add diversification to their portfolio, but education is key so that investors can choose their products wisely based on their goals.
Doug Krupa and Dan Parant are co-heads, KKR Private Wealth Partners