On this episode of The Impatient Investor, Andrew discusses private investments and explains why they are no longer exclusive to the mega-wealthy and well-connected. Andrew gives a few tips on allocating investments to private placement as well as some essential points to avoid the most common pitfalls.
“These types of opportunities were only available to the wealthy or well-connected with high barriers to entry. However, those days are over.”
It’s no secret that many of the country’s most prominent university endowments and private foundations have been hugely successful at investing and providing outsized returns for their constituents. Their success is attributed to them allocating more of their investment portfolio to private investments, including non-venture private equity, venture capital, private real estate, private oil and gas, natural resources, and precious metals. Private investments provide the types of returns Wall Street can’t compete with, but without the volatility. A recent article profiled Cambridge Associates, a prominent private investment firm that works with institutions and family offices, in a study that was recently published surrounding private investments. The study was based on a comprehensive survey of 132 prominent endowments and foundations, regarding their investing habits and financial performance over a 20 a year period.
In its analysis, Cambridge associates found that the top 25% performing institutions allocated at least 15% of their investible assets in private placements, and the top 10% allocated at least 40% to private placements. Among the best of the best, the Yale endowment, which allocated 80% of its portfolio to private investments and its fiscal 2018 year saw a return of 12.3%, in a year when the S & P was down 6.2%. Its 20-year return through 2018 was a robust 11.8% compared to 8.6% for the S & P 500.
In the wealthmanagement.com article, the author cited Cambridge associates, advocating that mega-wealthy families should ramp up their allocations to private placements and structure portfolio allocations in line with those endowments and foundations. Cambridge Associates asserts that families with multi-general wealth may be particularly well-positioned to consider allocating 40% or more of their assets to private investments.
Assuming these families have the requisite long-term timeline, horizon, patience, and ability to act quickly they stand to benefit not only from the potentially higher returns but also from the tax advantage nature of private investments. Life could get better after 40%. As a longtime advocate of an investor in private investments, I am in complete agreement with Cambridge Associates’ advocacy of higher allocations to this investment class that not only provides above-market returns but also acts as a hedge against inflation and as a buffer against Wall Street volatility.
However, there is one point in the article that I take issue with, and that’s the assertion that the vast majority of investors may not be in a position to invest that much in placements, given the structures, lockup periods, and relatively high expenses. The firm concedes the recommendation makes sense for only the mega-wealthy with the financial latitude to make the recommendation work. I disagree wholeheartedly with the position that a higher allocation strategy involving private placements only makes sense for the ultra-wealthy. This may have been true in the past where these types of opportunities were only available to the wealthy or well-connected with high barriers to entry. However, those days are over. Historically, private investments were the domain of the well-connected and affluent. Along came the Jobs Act and changed everything. Passed in 2012, with the rules finalized on May 16th, 2016, the Jobs Act was a watershed moment in the history of private investments designed to help small businesses raise capital by easing the advertising rules and allowing for widespread crowdfunding. The Jobs Act leveled the playing field.
Before the Jobs Act, the sale of securities in private companies were typically only accessible to the well-connected since advertising was prohibited. Now through advertising and crowdfunding, private investment opportunities are available to qualified investors like never before. They now have low barriers to entry without sacrificing return, with many examples of firms showing annual returns exceeding 10% since participation through the Jobs Act. Although you may not fall within a mega-wealthy class of investors, you would do well to follow a few key points when selecting private investments, because they are all not created equal. It’s essential to weigh all the factors when deciding where to commit your money. A strong alignment of interest between fund managers and investors is critical to success. With the right set of skills, experience, and focus, fund managers can capitalize on some of the information asymmetries that exist in private markets, allowing for the types of returns, some of the most successful institutional investors experience regularly. Unfocused objectives, mismatched skills for the specific investment class and lack of focus can sink a fund.
Additionally, fund managers with industry knowledge and experience have strategic and operational insights that can help improve company returns. Industry and market focus is also paramount to success. The contacts and networks developed around a particular sector focus provide fund managers with reliable trend information and deal flow. Unlike publicly traded companies that are beholden to the quarterly earnings report with public investors and manage accordingly private fund managers are more likely to follow a multi-year strategy to succeed. Investors should go into private investing with a long view strategy with typical lockup periods of five to ten years, investors should be prepared to deal with illiquidity investors that don’t rely on liquidity will reap the benefits.
Private investments inherently prevent a major risk that plagues the public markets, the behavioral tendency to buy or sell at the wrong time. Illiquidity saves investors from themselves and allows fund managers to sell portfolio investments when attractive exit points are available and not when public sentiment dictates, which often leads to panic and pandemonium in the public sector.
Private fund managers adhere to a natural sell strategy discipline and during market downturns, well-positioned funds who’d be able to make well-timed investments. This is only possible with a long-term strategy. Private investments are no longer exclusive to the mega-wealthy and well-connected and can be very rewarding with the right discipline and approach. Thanks to recent legislation, these opportunities are available to more qualified investors than ever before. The opportunities are there to build generational wealth, just like high-net-worth individuals. Just remember the essential key points to avoid the most common pitfalls, and you will be well on your path to enjoying true wealth building.