The super-rich’s view of increasing allocations to alternative investments

A big reason for the rise in interest is the proliferation of so-called evergreen or permanent funds, which allow individuals and institutions to immediately invest money 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’s US CIO office. Scansaroli also leads the portfolio advisory group, which works with the bank’s ultra-wealthy and institutional clients.

“The concept of investing in private markets is not new to our clients, but market accessibility has changed over the past few years with what many private sponsors call democratization,” he says.

The investment threshold in a permanent fund, for example, is often $25,000 instead of the $250,000 typical for private equity, making them more accessible to clients with $10 million or less, Scansaroli says.

Although wealthy investors are interested in increasing the percentage of their investments in private markets, most of their portfolios still lag behind the recommended levels. Ideally, their total holdings allocation should be 30% allocated to private markets (equity, debt and real estate), 30% allocated to public bonds and 40% to public stocks, he says.

Portfolios of investors who have done this over the past 15 years have returned 1.4 percentage points more than traditional portfolios with 60% in stocks and 40% in bonds, even after factoring in manager fees, Scansaroli says , citing aggregated data on manager performance compiled by Cambridge Associates, a Boston-based investment firm.

“We believe the new 60-40 mix of stocks and bonds — that’s the industry benchmark — is 40-30-30: 40% stocks, 30% bonds, 30% alternatives,” he says.

Penta recently spoke with Scansaroli about private markets and the factors wealthier investors might consider.

Why private markets?

Investing in private markets generally requires investors to be patient. Public funds or an exchange-traded fund can be bought and sold in a day, giving investors easy access to cash, but a private market investment can require cash to be released over a decade or more. But patience often pays off, as Cambridge Associates data shows, says UBS. In market jargon, this is called the ‘illiquidity premium’.

In a September report on private market activity, the firm included a chart showing that US private equity outperformed the S&P 500 over three-year, five-year and 10-year time horizons. Similar data also showed U.S. private investment in venture capital, credit and real estate also beating relative benchmarks.

Following Smart Money

A big reason wealthy people are considering increasing their funds for alternatives is what endowments and large single-family offices have done.

A 2022 survey by the National Association of College and University Business Officers found that the average endowment has nearly 40 percent in private equity and another 16.9 percent in hedge funds and 3.1 percent in real assets, such as gold, for a total of 60 % relative to the alternatives. This year’s UBS Global Family Office Report found that the 230 single-family offices it surveyed – with an average net worth of US$2.2 billion – had 34% allocated to private equity, 7% to hedge funds and 3% to real assets . Among family offices, US-based organizations are the most aggressive, with 47% in private equity and 10% in hedge funds.

Not only do endowments and single-family offices have significant allocations to private markets, these allocations are well-diversified across asset classes, managers and vintage years (the year the fund begins making investments).

For clients of its dedicated portfolio advisory group, UBS runs Monte Carlo simulations to predict possible return outcomes based on its market assumptions, and has built models to estimate future cash flows and valuations based on a model developed in 2001 d. for the Yale University Private Equity Portfolio.

By studying these cash flow simulations and graphs, combined with an individual’s future cash needs and risk tolerance, UBS can estimate how much of a given investment portfolio should be invested outside of public stocks and bonds.

“Ultimately, we believe that most clients who have an investment horizon of several decades can afford about 30% in alternatives,” says Scansaroli.

And that 30% should be roughly divided into 15% private equity, 10% private debt and 5% private real estate, he says. In all of these investments, UBS typically recommends that clients invest in anywhere from eight to 15 funds to avoid over-concentration in one fund or with one manager.

The emergence of permanent funds in these categories makes creating a diversified portfolio more manageable. However, there are some disadvantages: because permanent funds allow investors to invest immediately – instead of asking for cash after 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 holdings periodically si – they should set aside 10%-20% of the fund in cash. This can be a hindrance to portfolio performance, says Scansaroli.

Still, for clients with $10 million or less, the flexibility of these funds is enticing, he says. “We believed for a long time, but we especially believe now [current] market dynamics that investors really need to start thinking like an endowment.”