What is the favorite investment asset of the ultra-wealthy?
Check out the chart below:
The chart above represents the asset allocation of the members of Tiger 21, an exclusive peer-to-peer network of ultra-high-net-worth individuals from North America and Europe consisting of successful entrepreneurs and investors. A minimum of $50M in investable assets is required to join, and each quarter, the group publishes an asset allocation report showing where they placed their money.
According to the latest report, the members of TIGER 21 allocated 31% to private equities – an all-time high and a 2% increase from the prior quarter.
So what exactly is private equity, and why is that the preference by the ultra-wealthy for this asset class?
Whereas public equity is the equity investment in a registered public company in the form of stock, private equity is the equity investment in non-registered private companies. Whereas public equities are limited to investments in stocks, private equities can be in the form of stocks, limited liability company interests, and limited partnership interests.
So why do the ultra-wealthy prefer private equities, and why are they doubling down now and increasing their allocations?
The simplest reason is higher returns, but there are other reasons discussed below:
– Source: fsinvestments.com
The ultra-wealthy favor private equity because it outperforms public equities – and not by just a little. Over the long run, the performance of private equity is more than double that of public offerings.
Wall Street players will tell you that higher private equity returns come at the cost of higher risk. They’ll also tell you that when investing in private equity, you don’t have publicly available data to rely on to make educated investing decisions like with public equities, so there will be a higher risk of loss.
However, therein lies the secret to the success of the ultra-wealthy investor. They don’t want to rely on the data that everyone else has access to.
There are no information advantages, and because of that, finding high-growth opportunities can be a crap shoot. Instead, smart investors look to the private markets to find diamonds in the rough and high growth opportunities. And the #1 thing they’re interested in when prospecting for promising opportunities is who’s running the show. Scrutinizing the decision-makers is how the ultra-wealthy make informed decisions and mitigate risks. In the right hands, higher returns can be achieved at reduced risk.
The transparency of private companies is what allows ultra-wealthy investors to analyze deals.
Because the promoters of a private company’s securities offerings are typically its managers and principals, these decision-makers are always front and center and available to answer questions from prospective investors. This allows savvy investors to properly assess management’s experience, skills, knowledge, and expertise to evaluate the likelihood of success of a particular investment opportunity. By screening out unqualified management and gravitating towards experts in their segments with a track record of success, smart investors can extract the type of high returns private equity is renowned for but at less risk.
The promise of higher returns is not the only reason the ultra-wealthy have historically allocated heavily to private equity and why they’re increasing their allocations now. Market uncertainty and volatility are likely why they’re shedding stocks for private equity in the current economic environment.
In a recent Q&A session, Billionaire Ray Dalio recently warned that the next two years would be a “very risky time” in a recent Q&A session.
When asked about his thoughts on the U.S. economic outlook, Dalio responded:
“So, it looks likely to me that the financial/economic picture over the next year or two will be tough.”
When asked for his advice for investors in the face of the oncoming volatility, he responded:
“I believe that the key to good investing lies in achieving a balance of uncorrelated good return streams so that one’s portfolio has little or no bias to go up and down as conditions get better and worse.”
Uncorrelated returns are why the ultra-wealthy favor private equity and are increasing their allocations now. Unlike public equities that can be bought and sold instantly at the click of a phone, private equities are illiquid, with typical lockup periods starting at a minimum of three years. This illiquidity saves investors from themselves by preventing herd behavior that plagues public markets and causes crashes during volatile times like in 2008 and the early months of COVID in 2020.
Private equity was once restricted to institutional investors (i.e., endowments and pension funds) and ultra-wealthy connected investors. However, due to the loosening by the SEC of investor qualification requirements and advertising rules relating to exempt private offerings, private equity opportunities are now more accessible to more investors than ever.
Why leave high-risk-adjusted uncorrelated returns to just the ultra-wealthy? Everyone should be taking advantage of private equity opportunities.