Most people that invest in the market will generally buy publicly traded securities with the help of an online broker, mutual funds from fund companies (that in turn invest in public companies and bonds), or they may buy bonds in over the counter markets. Many times, investors will get these exposures simply by buying mutual funds in their 401(k)s or by navigating to a do it yourself type website like Vanguard where they might invest in a Target Date Fund or a balanced fund. In some cases, investors might get these exposures by working with an advisor. Whether they are buying the stocks directly or via a mutual fund, for the vast majority of retail investors, the stocks they own will be publicly traded stocks.
One of the key benefits of public markets is liquidity (ability to easily buy and sell) and accessibility, but one of the downsides can be greater volatility with prices going up and down all day.
A couple of key facts about public (listed) companies:
1. The number of listed companies (i.e. companies whose stocks trade publicly on exchanges) in the United States has declined by almost 50% over the past 25 years from 8,090 in 1996 to 4,266 and 2019.
2. Furthermore, companies are staying private longer before they go public.
3. That means a lot of the high growth early years and the related gains in shareholder value accrue to owners of companies in the private markets before the companies go public.
a. In 2021, the average company that went public was 11 years old and valued at $4.3 billion versus an average of 6 years old and a $700 million valuation in 2020.[i]
Below is a (non exhaustive) list of some of the major types of private market investments:
1. Private Equity
2. Private Credit
3. Private Real Estate
4. Hedge Funds
5. Private Infrastructure
The main obstacles keeping investors from private markets are the following:
1. Many investors are simply unaware of private markets.
2. Investors’ need for liquidity keeps them from private markets.
3. Inability to get access to high quality managers and do due diligence on managers.
4. Households don’t meet the minimum fund requirements in terms of investor net worth and/or income.
The securities in the public markets are terrific, achieve a lot of objectives, and serve a very important role. However, there are multiple shortcomings associated with limiting oneself to publicly traded securities.
A lot of what we have written to clients about in the last years has been surrounding the shortcomings of the traditional 60/40 portfolio or so called “balanced portfolio” which consists of 60% stocks of publicly traded companies and 40% bonds (issued by the federal government and primarily investment grade companies). We still think the
60/40 is a fine portfolio and some variation of it should form core holdings for most investors in or near retirement. We simply believe that we can do better by supplementing the “core” holdings, with a “satellite” of other asset classes and strategies.
At Meridian, we use private market options to achieve the following and so improve upon the 60/40:
1. To provide a set of non correlated returns thus achieving better diversification.
2. To lower interest rate risk (this risk is described below).
3. To increase income.
4. To limit downside capture (limit the amount an investment/portfolio goes down when the market goes down).
5. To add an inflation hedge (in some cases).
6. To act as a stabilizing force on the overall portfolio and limit portfolio volatility.
I do not want to digress too much but I want to spend some more time talking about interest rate risk for some important reasons. This risk has perhaps been the one that has injured investors near retirement or in retirement the most in the last few years. Let us start by reviewing one piece of common wisdom that is perhaps is partially correct. That common wisdom says that stocks are risky and bonds are safe. What we should say is that the credit risk of high quality bonds is low. But that doesn't mean the overall risk associated with that bond is low.
In addition to credit risk, there is another key risk and that is called interest rate risk. As interest rates have been coming down for decades and the price of bonds have been going up for decades, this risk has receded from investors awareness. Because the price of interest rates and the price of bonds move in different directions, as interest rates went up beginning in the latter half of 2021 going through October 2023, this has directly and materially cut into the price of fixed income investments in client portfolios. In 2021, clients had the option of either investing, for example, in a 6 month Treasury and getting 0.2% return or investing in a 10 year Treasury and getting 1.5% return (or perhaps just a little bit more yield for investment grade corporate bonds). However, the longer the term of the fixed income investment, the higher the interest rate risk. In other words, the longer term a bond is for, the more the price of that bonds will go down when interest rates go up. The challenge is that in most markets, longer term bonds pay a higher yield (interest rate), but that comes with more interest rate risk. There are more vehicles in the private markets in terms of income paying and debt vehicles that carry significantly less interest rate risk.
Getting back to the public markets, one of the virtues of the public markets is that securities can be bought and sold in an instant. In other words, liquidity. One of the virtues of the private market is that securities cannot be sold bought and sold in an instant. Private markets and alternatives move very slowly. That also means the price of their securities are not gyrating up-and-down all day. Not all private market investments are the same (such as hedge funds, venture capital, private equity), but the asset classes that we focus on at Meridian (private real estate and private credit) are broadly speaking, more likely to be priced at their intrinsic value as opposed to the passions of the crowd. For example, the key non traded real estate investment trust we use is independently valued on a quarterly basis and it is on that basis upon which Net Asset Value (NAV) and thus share redemption value is based. This is very different than how a publicly traded REIT (real estate investments trust) is priced. Public REITS effectively carry much more interest rate risk.
In many of the private market options we focus on, there is either monthly or quarterly liquidity but some may come with penalties for liquidating In the first year. The reason is the strategies associated with these asset classes require time to work so borrowers need to have reliability and predictability of funding certain investments. But for investors who are investing for their retirement and throughout their retirement, that would be a non factor.
There are becoming more opportunities to invest in the private markets for individual investors as private markets have historically been the domain of institutions and the high net worth and ultra-high net worth. They are however beginning to become more accessible. It is important to note due diligence and identifying top tier fund managers is key. There is a wide dispersion from between the better performing managers and lower performing managers in the private markets. A history and knowledge of the asset class is key and in some areas (like private credit), strong relationships and good reputations with sponsors (borrowers) is important.
To learn more or inquire as to whether private markets are appropriate for you, reach out to us to schedule an introductory phone call at (843) 212-6828 or email@example.com.
Joshua Henry is the founder and Managing Principal of Meridian Financial Advisory (meridianria.com), an independent, fee-based wealth management company located in South Carolina, serving people locally and across the country, that focuses on providing wealth management solutions primarily to affluent individuals over age 50 and their families. Joshua is passionate about helping people have a better life by designing and implementing customized financial plans that bring clarity and confidence. Joshua is a CERTIFIED FINANCIAL PLANNER™(CFP®), a Certified Investment Management Analyst® (CIMA®) Professional, and earned a Bachelor of Arts degree in Political Science from Cedarville University and a Master of Business Administration degree with a concentration in Corporate Finance from Salve Regina University. The courses for the Corporate Finance concentration were taken from the Kelley School of Business at Indiana University. He has held workshops on Social Security Claiming Strategies, IRA Planning, and Career Coaching for Executives in between jobs. Josh has also taught finance at the university level. When he’s not working, Josh teaches adult Sunday School at his church in Pawley Island, SC. He enjoys traveling, reading, and time with his family. To learn more about Josh, connect with him on LinkedIn.
[i] "The Importance of Private Markets," iCapital, 9-23-2023, https://icapital.com/insights/private-equity/the-importance-of-private-markets/
[ii] Graphic from The World Bank in "The Importance of Private Markets," iCapital, 9-23-2023, https://icapital.com/insights/private-equity/the-importance-of-private-markets/