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Why own private assets?
In this uncertain market environment, investors struggle to enhance returns and reduce risk. Private assets — those not traded on public exchanges, including debt, equity, real estate and real assets — may help achieve those goals. Investors should consider three important benefits as they evaluate allocating to private markets.
Private market pricing helps avoid public market noise
Inflation-linked private assets like real estate and farmland were one of the few refuges in the market upheaval of the last few years, and most private assets avoided the knee-jerk reactions of public markets.
Why the difference? Public markets tend to sell off more than fair value because they often rely on the wisdom of crowds and are subject to moments of panic. Private markets rely on the wisdom of experts to reflect economic conditions in their valuations.
Return and income potential
Characteristics offer opportunity
The illiquidity of private markets has been viewed as a limitation, but that same illiquidity also creates opportunities. The investment time horizon is generally longer for private markets, allowing for M&A activity and longer-term turnarounds. Majority or complete ownership in private companies helps better align interests because management is held more accountable. Similarly, private transactions generally offer far greater transparency to the buyer than what is available to public market investors.
A wider opportunity set is another important factor. There are more than 10 times the number of private companies as public ones,1 and public REITs account for only 9.4% of the approximately $20 trillion U.S. commercial real estate market.2 Illiquidity has historically been a barrier to entry, with even large private market investors investing only a portion of assets in private markets. Investors therefore face less competition and may negotiate lower equity valuations and higher bond yields.
Cash flows can increase along with inflation
Assets that have provided durable returns during both recessions and bouts of unexpected inflation may be attractive portfolio diversifiers. For example, private real estate and farmland provide cash flows that increase with inflation. At the same time, shelter and food are defensive businesses that serve basic needs in periods of economic contraction.
Conversely, long Treasuries and commodities tend to perform only in recessionary or inflationary periods, and neither one has offered compelling long-term returns.
Does your allocation measure up?
Portfolio plans vary based on investor profiles and market conditions, but all plans begin with a strategic allocation. We believe portfolios benefit from allocating to a wide array of asset classes, including private market assets.
In this issue
1 Data source: listed: World Federation of Exchanges (WFE); unlisted: U.S. Census Bureau.
2 Estimating the size of the Commercial Real Estate Market in the U.S., NAREIT, 30 Jun 2022. Most recent data available.
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Important information on risk
All investments carry a certain degree of risk and there is no assurance that an investment will provide positive performance over any period of time. Equity investing involves risk. Investments are also subject to political, currency and regulatory risks. Diversification is a technique to help reduce risk. There is no guarantee that diversification will protect against a loss of income. Debt or fixed income securities are subject to market risk, credit risk, interest rate risk, call risk, derivatives risk, dollar roll transaction risk, and income risk. As interest rates rise, bond prices fall. Foreign investments involve additional risks, including currency fluctuation, political and economic instability, lack of liquidity, and differing legal and accounting standards. These risks are magnified in emerging markets.
As an asset class, real assets are less developed, more illiquid, and less transparent compared to traditional asset classes. Investments will be subject to risks generally associated with the ownership of real estate-related assets and foreign investing, including changes in economic conditions, currency values, environmental risks, the cost of and ability to obtain insurance, and risks related to leasing of properties. Real estate investments are subject to various risks, including fluctuations in property values, higher expenses or lower income than expected, and potential environmental problems and liability. Please consider all risks carefully prior to investing in any particular strategy. A portfolio’s concentration in the real estate sector makes it subject to greater risk and volatility than other portfolios that are more diversified and its value may be substantially affected by economic events in the real estate industry. International investing involves risks, including risks related to foreign currency, limited liquidity particularly where the underlying asset comprises real estate, less government regulation in some jurisdictions, and the possibility of substantial volatility due to adverse political, economic or other developments. As an asset class, agricultural investments are less developed, more illiquid, and less transparent compared to traditional asset classes. Agricultural investments will be subject to risks generally associated with the ownership of real estate-related assets, including changes in economic conditions, environmental risks, the cost of and ability to obtain insurance, and risks related to leasing of properties.
Investors should be aware that alternative investments including private equity and private debt are speculative, subject to substantial risks including the risks associated with limited liquidity, the use of leverage, short sales and concentrated investments and may involve complex tax structures and investment strategies. Alternative investments may be illiquid, there may be no liquid secondary market or ready purchasers for such securities, they may not be required to provide periodic pricing or valuation information to investors, there may be delays in distributing tax information to investors, they are not subject to the same regulatory requirements as other types of pooled investment vehicles, and they may be subject to high fees and expenses, which will reduce profits. Alternative investments are not appropriate for all investors and should not constitute an entire investment program. Investors may lose all or substantially all of the capital invested. The historical returns achieved by alternative asset vehicles is not a prediction of future performance or a guarantee of future results, and there can be no assurance that comparable returns will be achieved by any strategy.
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