There are two ways to protect your children in the summer from the harmful effects of the sun:
You can keep them inside all summer; or
Make sure they have plenty of sunscreen on when they go outside.
The first option will ensure your children will never get sunburnt, but it may also take the fun out of the summer by preventing them from going outside to play with their friends or to engage in outdoor activities like swimming. The sunscreen option allows them to still have fun outside while safeguarding them from the harmful effects of the sun.
In the world of investing, you can protect yourself from exposure in two similar ways. On Wall Street, the popular buzzword for protection against exposure is diversification. The problem is that when you diversify away risk, you also diversify away your returns. Just like there is no joy in staying inside to avoid the sun, there is no joy in diversifying if it means low returns.
What if there was a way to reduce your exposure to risk and loss while maintaining high returns? There is a way, and the ultra-wealthy are well aware of it.
As demonstrated by the asset allocations of the ultra-wealthy members of investing network Tiger 21, the ultra-wealthy prefer private equities over public equities. That is largely due in part to private equities offering above-market returns while insulating portfolios from broader market exposure to volatility. But that’s only part of the story.
Why Ultra-Wealthy Investors Prefer Private Equity Over Public Equities
Ultra-wealthy investors are increasingly gravitating towards private equity over public equities to a greater degree, and the average investor is taking note as alternatives such as private equities are increasingly becoming more popular with all investors. This trend reflects a paradigm shift where investors are no longer content with sacrificing returns in the name of diversification. Instead, investors are discovering that it’s possible to mitigate market risks while maintaining high returns with alternatives like private equities.
The allure of private equity can be boiled down to insulation from market volatility, access to exclusive opportunities, the potential for higher returns, and tax efficiency.
Insulation from Exposure
Unlike public equities, which are subject to market volatility and economic fluctuations, private equities are less correlated with public market movements driven by fickle investor sentiment. This low correlation shields investors from the unpredictable swings of the stock market, insulating portfolios from potential losses.
Exclusive Opportunities and Higher Returns
Private equity offers access to investment opportunities that are not available in public markets. These include direct ownership stakes in promising companies, participation in unique real estate projects, and investments in specialized industries. Such opportunities often come with the potential for higher returns, driven by active management. The ability to invest in these exclusive opportunities aligns with the entrepreneurial spirit of many ultra-wealthy individuals.
Moreover, the hands-on approach of private equity firms and the experienced and knowledgeable hands of management that guide them can lead to substantial value creation. This active management can result in the forced growth and appreciation of a company and, therefore, an investment in such a company. This is in contrast to the relatively passive nature of public equity investments, where returns are more dependent on market trends and company performance.
Tax Advantages
Tax efficiency is another critical factor driving the preference for private equity among the ultra-wealthy. Investments in private equity structured as partnerships often benefit from lower tax rates on capital gains compared to income generated from other sources, as well as the pass-through of valuable tax deductions. This tax advantage enhances wealth preservation and growth, making private equity a more attractive option for high-net-worth individuals looking to minimize their tax liabilities.
Breaking from the Herd
Because of liquidity, public equities are subject to the whims of investor sentiment, regulatory changes, and macroeconomic trends, leading to higher volatility and unpredictability. In contrast, private equity investments are typically held for longer periods, with returns generated through strategic initiatives rather than market speculation.
This long-term approach offers ultra-wealthy individuals with long-term investment horizons the promise of higher returns in exchange for a willingness to lock up capital for extended periods.
No Longer Exclusive to the Ultra-Wealthy
Historically, private equity was the domain of connected and wealthy individuals or large institutional investors. However, regulatory and technological advancements have opened up the world of private equity to more investors.
Digital platforms, as well as revamped investment frameworks, have lowered the barriers to entry, allowing a broader range of investors to benefit from the diversification and high returns offered by private equity.