The ultra-wealthy have long relied on private equity (i.e., investments in private companies) for recession and inflation-insulated returns. In light of recent economic uncertainty, savvy investors leaned more heavily on private equity to weather the current storm.
One such group of ultra-wealthy investors offers a fairly accurate glimpse into how these savvy investors allocate their assets and how they have adjusted their strategy in light of recent economic developments.
In 2022, inflation, war, high energy prices, supply constraints, recession fears, political conflict, and general economic uncertainty wreaked havoc on the public markets. Inflation hit 9.1% In June, a rate not seen since the ’80s.
The result was market volatility:
- For 2022, the S&P 500 was down 19.44%. The Dow was down 8.789%, and for crypto, Bitcoin was down 65%.
- As the public markets experienced turmoil, smart ultra-wealthy investors allocated a higher proportion of their assets to private equity. The members of Tiger-21, a social investing network (minimum of $50M in investable assets required for membership), increased their holding in private equity from 22% to 27% in anticipation and response to market turmoil.
Smart investors are attracted to private equity because they offer potentially higher returns at lower risk. The SEC acknowledged this in a recent symposium pushing to make private investments more accessible to more qualified investors.
In a speech at the PLI Investment Management Institute 2020 in the summer of 2020, Dalia Blass, the Division of Investment Management Director at the SEC, suggested that more Main Street investors should have access to private markets.
Why? In her own words:
“Private investments have the potential to provide stronger returns and diversification for investors . . .”
Private equity can earn significantly higher returns than public equities in the right hands. The following chart reflects this assessment.
The main takeaway from the above chart is that private investments have the potential to generate higher returns than public options. Still, they also come with higher risk because of inexperienced promoters and operators. But, if private investments carry higher risk, how can they generate higher risk-adjusted returns than public funds? The answer is the experience of private fund managers.
In the right hands of experienced and knowledgeable managers, risks can be mitigated to where higher returns can be achieved at lower risk levels. By teaming with the right partners, smart investors have learned to mitigate risk while not sacrificing high returns.
Why Venture Capital?
Among the various subsets of private equity, a favorite of the ultra-wealthy is venture capital (VC) – a form of private equity that investors provide to startup companies and small businesses that are believed to have long-term growth potential. Venture capital funds allow investors to join them on the path of growth and prosperity.
Long-term growth potential translates to higher returns, and the data supports VC returns outpacing stock returns. Two indices, the REFINITIV VC Index and the Cambridge Index, both well-known indices, have been tracking VC performance for years.
Data from both indices support VC returns outpacing public market returns:
Besides the higher risk-adjusted returns, private equity in general and VC specifically also offer the following potential benefits:
- Cash flow.
- Insulated from Wall Street volatility.
- Hedge against inflation.
- Tax benefits.
- Ability to leverage the expertise and knowledge of others to create multiple streams of passive income.
The ultra-wealthy have long relied on alternative assets like venture capital to take advantage of recession-proof and inflation-insulated income and appreciation while reaping the various tax benefits not available with public equities, thus allowing them to keep more of what they make.
While the stock and crypto markets reel from inflation and recession fears, the ultra-wealthy are insulating their income and preserving their capital by leaning on private equity and venture capital. They can key on these assets by tuning out all the noise and hype buzzing on the internet, social media, and around the water cooler.
While the average investor chases shiny objects, the ultra-wealthy turn to private equity and VC opportunities best equipped for helping investors weather economic storms.