The Super-Rich Look to Boost Allocations to Alternative Investments (From Barron’s)
~ Wednesday, November 15, 2023 Blog Post ~
By Abby Schultz, October 31, 2023
Wealthy individuals who work with a specialized portfolio advisory group at UBS are increasingly interested in private markets.
In response, the advisory group has raised its recommended allocations to private equity, private debt, real estate, structured products, and hedge funds for these clients from about 16% to about 22% of their portfolios.
A big reason for the uptick in interest is a proliferation of so-called evergreen, or perpetual, funds that allow individuals and institutions to invest cash immediately in private businesses, while offering lower minimum investment thresholds and more flexibility to withdraw assets, according to Daniel Scansaroli, head of portfolio strategy in UBS’ CIO Americas office. Scansaroli also oversees the portfolio advisory group that works with the bank’s ultra-high-net-worth and institutional clients.
“The concept of investing in private markets is not new to our clients, but the accessibility of the market has changed in the last couple of years with what many of the private sponsors are calling a democratization,” he says.
The investment threshold in a perpetual fund, for instance, is often US$25,000 instead of the US$250,000 typical of private equity, making them more accessible to clients with US$10 million or less, Scansaroli says.
Though wealthy investors are interested in boosting the percentage of their investments in private markets, most of their portfolios still lag recommended levels. Ideally, the overall distribution of their holdings should be 30% allocated to private markets (in equity, debt, and real estate), 30% allocated to public bonds, and 40% to public stocks, he says.
The portfolios of investors who did that for the past 15 years returned 1.4 percentage points more over traditional portfolios with 60% in stocks and 40% in bonds, even factoring in manager fees, Scansaroli says, citing pooled data on manager performance collected by Cambridge Associates, a Boston-based investment firm.
“We believe that the new 60–40 stock-bond mix — that is a benchmark in the industry — is 40–30–30: 40% equities, 30% bonds, 30% alternatives,” he says.
Penta recently spoke with Scansaroli about the private markets, and factors wealthier investors might consider.
Why Private Markets?
Investing in private markets typically requires investors to be patient. A public stock or exchange-traded fund can be bought and sold in a day, giving investors ready access to cash, but a private-market investment can require letting go of cash for a decade or more. But having patience often pays off, as the Cambridge Associates data shows, UBS argues. In market jargon, it’s called the “illiquidity premium.”
In a September report on private-market activity, the firm includes a chart that shows U.S. private equity outperforming the S&P 500 for three-year, five-year, and 10-year time horizons. Similar data also shows U.S. private investments in venture capital, credit, and real estate, also outperforming relative benchmarks.
Following the Smart Money
A big reason wealthy individuals are considering upping their allocations to alternatives is that’s what endowments and large single-family offices have done.
A 2022 study from the National Association of College and University Business Officers found the average endowment has nearly 40% in private investments and another 16.9% in hedge funds and 3.1% in real assets, such as gold, for a total of 60% to alternatives. This year’s UBS Global Family Office Report found that 230 single-family offices it surveyed — with an average net worth of US$2.2 billion — had 34% allocated to private investments, 7% in hedge funds, and 3% in real assets. Among the family offices, the U.S.-based organizations were the most aggressive, with 47% in private investments and 10% in hedge funds.
Not only do endowments and single-family offices have significant allocations to private markets, these allocations are well diversified in terms of asset classes, managers, and vintage years (the year a fund begins making investments).
For its specialized portfolio advisory group clients, UBS runs Monte Carlo simulations to predict possible return outcomes based on its market assumptions, and it’s built out models for estimating future cash flows and valuations based on one developed in 2001 for Yale University’s private equity portfolio.
By studying these simulations and cash-flow schedules, in combination with an individual’s future needs for cash and their risk tolerance, UBS can estimate how much of a given investment portfolio should be invested outside of public stocks and bonds.
“At the end of the day, we believe that most clients who have a multiple decade investment horizon can tolerate about 30% in alternatives,” Scansaroli says.
And that 30% should be roughly divided with 15% in private equity, 10% in private debt, and 5% in private real estate, he says. Across all these investments, UBS usually recommends clients invest in anywhere from eight to 15 funds to avoid being too concentrated in one fund or with one manager.
The advent of perpetual funds across these categories makes creating a diversified portfolio more manageable. There are some disadvantages, however: because perpetual funds allow investors to invest immediately — instead of asking for cash once they are ready to buy a company, in the case of a private-equity fund — and because they allow a small percentage of investors to liquidate their holdings periodically — they have to set aside 10%-20% of the fund in cash. That can be a drag on portfolio performance, Scansaroli says.
Yet, for clients with US$10 million or less, the flexibility of these funds are enticing, he says. “We’ve believed for quite some time, but especially we believe now with [current] market dynamics, that investors do have to start thinking like an endowment.”
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