In an increasingly tumultuous world, investors lack the certainties of the past. With low rates and low yields seemingly set for the long term, public markets have been drained of the solidly dependable alpha that investors could once rely on, and even equity markets are increasingly dominated by concerns over volatility and froth.
The reality is that a significant proportion of today’s economic growth is found outside the public realm. As a result of this, alternative investments such as private markets are generating ever-greater interest as sources of diversification and returns.
Over the decade through 2020, assets under management (AUM) in private markets around the world grew 170% to USD4 trillion, far outpacing expansion in their public counterparts, which grew 100%.1 Hedge fund capital, meanwhile, jumped by a record USD290 billion in the last quarter of 2020 to USD3.6 trillion.2 And the number of family offices worldwide grew 38% in the two years through Q2 20193, with the pace of expansion growing faster in Asia than in any other region.
“We believe the shift to allocate more of one’s portfolio to alternative investments is here to stay,” says Lim Leong Guan, Global Head of Products at Bank of Singapore. “Sophisticated investors around the world recognize the benefits of alternative investments in bringing diversification and differing sources of returns to their portfolios which they cannot find in traditional asset classes. Alternative investment strategies are also well positioned to allow investors to reap alpha and generate returns that are independent of market movements, provided manager and partner selection is done well.”
By 2025, AUM in global private markets is estimated to reach USD13.7-15.0 trillion4 – and hedge fund capital to grow to USD4.3 trillion5 – as more investors recognise that the need to incorporate a diverse range of quality private assets into their portfolios is more pressing than it has ever been.
New Avenues of Wealth Generation and Diversification
For investors such as high-net-worth individuals and family offices, that need has resulted partly from changes in the private wealth-management universe. Traditionally, that universe was often driven primarily by the imperatives of preservation and protection; the desire to ring-fence existing wealth and ensure the longevity of a legacy. But as prosperity spreads eastwards, financial interests grow more geographically diverse, and returns from traditional asset classes dwindle, the demand for alternative investments to offer wealth generation has become more pressing.
Alternative investments not only offer the prospect of higher returns than their public-market counterparts, they also provide another key factor in the search for diversification; a lack of correlation (and a reduction of exposure) to public markets. A customary well-rounded portfolio is built with assets that perform well under different market conditions; bonds that rise when stocks are struggling, and so on. But that traditional recipe of equities, fixed income and cash looks increasingly fragile in a world where bond yields are negligible, and cash generates little or no interest.
“The breadth and depth of investment opportunities outside traditional public markets is huge and highly varied,” said Leong Guan Lim, Global Head of Products at Bank of Singapore. “You've got private equity, private debt, venture capital, hedge funds and real estate. There's a whole range of different investment opportunities that the average investor would probably find quite hard to access. And while it’s not for every investor, in most cases some allocation into alternative investments classes would certainly support an investor’s long-term investment objectives.”
Sophisticated investors are realising that alternative investments such as private markets offer opportunities that are increasingly difficult to find through mainstream channels, but despite this accelerating demand, the actual migration of money into private investments is lagging behind the level of interest.
Research shows that even as almost all categories of Limited Partner (LP) – from sovereign wealth funds to pension funds and insurance companies – are consistently raising their target allocations every year, most of them are still not very active in private markets. In fact, the gap between LPs’ target allocations to private investments and actual private-market investments is an estimated USD500 billion.6
Overcoming the Gap
Firstly, a commitment to private markets does not mean an immediate deployment as capital is called only upon identification of an investment.
Investors may also begin to receive capital back as exits occur, even as they are still investing capital to support other private companies that require additional funding to grow. This results in an investor’s net investment at any one time being lower than the original commitment amount.
The second obstacle is accessibility. Alternative investments are not nearly as transparent as traditional public markets and are not set up to facilitate investment by individuals. While opportunities for individuals to invest directly into private companies or private market funds may present themselves occasionally, often through a personal connection, the level of due diligence required in this comparatively unregulated market is beyond the capabilities of most high-net-worth investors, who may lack the resources, expertise and ability to actively manage private investments.
Equally, because the opportunities for passive private investments are limited or non-existent, manager selection is critical.
The Importance of Manager Selection
Investors need to be discerning about the private-market opportunities that come their way. Without a manager who understands the market opportunity and the partners leading the investment, the chances of a misstep are significantly higher. Making the right investment decision is crucial, especially given that private-market investments are usually held for the long term and thus are not as liquid as public-market investments.
“Private-market funds have the greatest level of return dispersion, where the difference between the top-performing and bottom-performing managers is stark,” Lim says. “In addition, deciding to participate in a private-market fund is often a long-term commitment and it is hence much more important for investors to carefully choose which funds to participate in.”
For the vast majority of individuals, entrusting capital to professional private-equity managers with the experience and resources necessary to properly select, manage and exit investments is the best way of gaining private-market exposure.
“Bank of Singapore curates private-market opportunities for our clients,” Lim adds. “With a dedicated team sourcing, researching and monitoring opportunities in this space, we seek to be that resource for clients to assess the appropriate investment opportunities and build a cohesive private-market portfolio with us. We are also aware of the varying needs of our clients in relation to private-market investments and have sought different ways to cater to their unique needs.”
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