Perspectives
07 March 2024
Amid challenging market conditions in recent years, including high inflation, rising interest rates and increased geopolitical uncertainty, interest in alternative investments has grown exponentially.1 Investors are seeking access to alternatives as a potential means of insulating their portfolios from market swings while enhancing returns.2
Alternatives have long been a key portfolio allocation for institutions and ultra-high-net-worth individuals. However, many individual investors have had limited access due to strict qualification criteria and high minimums. In many cases, a lack of relationships and an inability to conduct due diligence have kept all but the wealthiest investors away.3
Demand has, however, intensified as individuals seek diversification and new asset classes to offset the shrinking number of public investment opportunities, notably on the equities side. Currently, 87 per cent of US companies with $US100+ million in revenue are privately owned.4 Additionally, the number of US public companies has declined by about a third over the last 25 years, according to Bain & Company.5
Individual investors control over half of global wealth, but only allocated 5 per cent of their wealth to alternatives as of 2023.6 Preqin Global Alternatives predicts, however, that global assets under management (AUM) for alternative investments will rise to $US23.3 trillion in 2027, a compound annual growth rate of 9.3 per cent from 2021 levels of $US13.7 trillion.7
Given increased demand in the current macroeconomic landscape, policymakers and asset managers are working to broaden access to the asset class for a wider range of investors.8 This presents a clear but complicated opportunity for financial advisors looking to offer them to their clients.
In recent decades, US regulators viewed the complexity, illiquidity and lack of transparency of alternatives as too risky for average investors, setting qualification criteria such as high income and asset thresholds to restrict access.9 “These regulations rested on the assumption that private market investing was only suitable for the wealthiest investors,” says Andrea Mody, Managing Director, US Wealth Private Markets Head, Macquarie Asset Management. “That theory has since evolved.”
In the last few years, policymakers have worked to modify restrictive regulation. In 2020, the US Securities and Exchange Commission (SEC) effectively expanded the market for alternative investments in the US by broadening the definition of accredited investors, moving beyond financial metrics such as assets and income to include the consideration of expertise and knowledge.10 These modifications are based on defined measures of professional experience or certifications in addition to the existing tests for income or net worth.
In May 2023, the US House of Representatives passed a bipartisan bill that further relaxed the qualifications required to become an accredited investor, giving even more individuals the ability to invest in private markets regardless of wealth or income levels.11 If entered into law, it will require the SEC to create an exam that measures an investor’s knowledge. Any individual who passes – regardless of income, expertise or wealth – would receive accreditation. Given the implications, investors and asset managers alike are paying close attention as the bill makes its way through Congress.
At the same time, the SEC is continuing to ensure safeguards, clarifying the definition of what constitutes an accredited investor, identifying more ways to measure sophistication, and offering educational opportunities about strategies and financial resiliency to manage the risk of loss.12 “A broader range of individuals now find themselves on a more level playing field alongside investors traditionally considered to be more sophisticated, like institutions and the ultra-wealthy,” Mody adds.
Institutional investors have historically held higher average allocations to alternatives than high net worth investors – 23 per cent13 compared to 5 per cent14.
Alternative asset managers, however, are looking to individual investors to expand their assets under management because many institutions are already fully allocated or reaching their target allocations. It’s a supply and demand issue as product supply in some cases exceeds capital availability.15 In 2023, private equity fundraising supply was 3.2 times higher than institutional demand, the widest gap since the global financial crisis, according to Bain & Company.16
Even prior to these challenges, many asset managers were eyeing the retail market as a particularly attractive source of funding.
It would be a mistake to think of individual investors as ‘amateurs.’ Today, they have access to information and market insights, and they understand that over the last 20 to 30 years, alternative investments such as private equity have outperformed traditional portfolios of stocks and bonds. So, they are absolutely looking at alternative asset classes to enhance their portfolios.”
Mitchell Tanzman
Co-Chair, Macquarie Asset Management Wealth Solutions
As a result, institutional managers are viewing individual investors as a new source of capital, removing barriers to entry, educating financial advisors and creating new offerings that democratise access.
At a time of muted expectations for public markets, alternative investments may provide an opportunity for individual investors to potentially achieve better returns with reduced volatility. A recent Bain study indicated that more than half of very-high- and ultra-high-net-worth individuals and nearly 40 per cent of high-net-worth individuals plan to increase their allocation to alternatives over the next three years.17
Financial advisors have taken notice and are seeking education on the potential benefits and risks of alternatives, so they are better equipped to offer them to their clients. This involves gaining an understanding of fund structures and strategies, the impact of illiquidity on portfolio construction, capital call procedures and best practices for communicating fund performance to clients.
Forty-four per cent of financial advisors believe educating clients on the investment characteristics and value proposition of alternatives is a key challenge, according to research from Cerulli Associates.18 Macquarie Group recognises the opportunity to help financial advisors and clients navigate new and unfamiliar asset classes, serving as a resource for product education as well as due diligence support.
Macquarie Asset Management Wealth Solutions has deep expertise in the alternatives space, having developed many of the fund structures used today. The team has developed resources specific to alternative asset classes such as private equity, hedge funds, infrastructure and the energy transition. Asset-class specialists curate and conduct extensive due diligence on a wide breadth of alternative strategies, offering wealth advisors practical education on private market concepts, investment opportunities and structures.
“Macquarie Asset Management Wealth Solutions adds value by, among other things, appreciating the challenges to adoption and incorporating education in all of our product offerings,” says Ruth Goodstein, Chief Operating Officer at Macquarie Asset Management Wealth Solutions. “We believe supporting financial advisors and their clients in overcoming the education gap is critical to unlocking new, differentiated investments for individuals seeking portfolios that include private market allocations.”
Investor considerations
While the benefits of investing in private equity may be considerable, this asset class is not for everyone. Of course, private equity investments involve significant risks, including a total loss of capital. The risks associated with private equity arise from several factors, including limited diversification, the use of leverage, limited liquidity and capital calls made on short notice (failure to meet capital call obligations may result in consequences including a total loss of investment). Qualified investors who appreciate the risks and potential rewards of private equity may wish to consider an appropriate allocation to the strategy.
Risk considerations
Alternative investments are speculative and involve substantial risks and conflicts of interest. Investors may lose some or all of their investment. Alternative investments may not be appropriate for all investors. This document does not constitute an offer to purchase any securities or obtain investment advisory services. The risks associated with alternative investments arise from several factors, depending on the specific type of investment. Some alternative investments:
Before investing, review the detailed explanation of risks as well as all other information in any offering materials. This does not constitute tax or legal advice. Please contact your tax and legal advisors regarding your specific situation. There are risks associated with investing in alternatives. There is no assurance that objectives will be achieved or that an investment program will be successful. All investments in securities involve risk of the loss of capital. Alternative investments are sold to qualified investors only by a Confidential Offering Memorandum or Prospectus. Alternative investments provide limited liquidity and include, among other things, the risks inherent in investing in securities and derivatives, using leverage and engaging in short sales. An investment in an alternative investment fund is speculative, involves substantial risks and should not constitute a complete investment program. An alternative investment fund may be highly leveraged and the volatility of the price of its interests may be significant. Alternative investments may involve complex tax structures and there may be delays in distributing important tax information. Alternative investment funds may not be subject to the same regulatory requirements as mutual funds, and their fees and expenses may be high. This summary is for informational purposes only and does not constitute an offer to sell or a solicitation of an offer to buy interests in any fund. Interests are not deposits or obligations of, or guaranteed or endorsed by, any bank or other insured depository institution, and are not federally insured by the Federal Deposit Insurance Corporation, the Federal Reserve Board or any other governmental agency.
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