Alternative investments are increasingly beginning to find their way onto the radar of retail investors, largely for four reasons:
- Investors are tired of market volatility,
- Equities have remained expensive and future returns look less appealing (relative to some other asset classes),
- Potential inflation hedging properties of alternative investments, and
- Technology is democratizing broader access to alternative investments.
One reason for investors to consider including alternative investments in their allocation strategy is the extreme volatility experienced by the public markets over the past few years, most notably the volatility experienced in 2022. Even though the COVID correction in March of 2020 was short lived, it still made an impression on investors. The volatility in 2022 is reopening those wounds. Alternative investments have generally been uncorrelated with public markets and adding them to a portfolio has the potential to increase diversification while reducing overall portfolio volatility. In 2022, while most public stock indexes were negative, many real estate indexes mostly experienced positive returns.
In a survey conducted by London-based Connection Capital1 of their 1500 high-net-worth clients, 50% of the 230 respondents allocated at least 10% of their portfolio to alternatives in 2018. The now upward trend has increased year after year to 74% in 2022.
Why the migration from publicly traded stocks and bonds (the 60% stock/40% bond portfolio) to alternative investments? Stock market valuations such as the S&P 500 5-year normalized P/E, S&P 500 dividend yield, Shiller’s Cape and the equity market to GDP ratio all exhibit values that lie in the upper range of their respective historical observations. These inflated metrics appear indicative of an over-valued state of public equity markets. Additionally, at times when the publicly traded stock markets have struggled, bonds have historically been a safe haven. However, with the current inflationary environment and rising interest rates depressing bond values, the 60/40 portfolio doesn’t appear to be the answer. In contrast, alternative investments, such as real estate, have the ability to raise their rents during periods of inflation thereby providing a level of inflation hedge. The average annual total return for commercial real estate properties, as measured by the National Council of Real Estate Investment Fiduciaries (NCREIF) between 1980 and 2022, stood at 8.97%, which is higher than the average annual inflation of 3.32% recorded over the same period.
Lastly, access to many alternative investments has become democratized as a result of platform and structural developments. Once the bastion of institutions and super high net worth individuals, alternative investments are now more accessible. Additionally, as a result of lower minimum investments and greater investment transparency, alternative investments are more accessible and easier to evaluate though investor qualification and inexact valuations still remain.
1Connection Capital’s Annual Private Client Alternative Investment Survey of their private client investors about their thoughts on alternative investments (classified in the survey as Private Equity; Private Debt; Commercial Property; Infrastructure; Alternative Fund Strategies) and portfolio allocation against the prevailing economic and market environment. Survey responses were completed between June 8 and June 23, 2022. Connection Capital is a London-based alternative investments platform enabling experienced high-net-worth private investors to invest directly in private equity and private debt transactions sourced and managed by Connection Capital.
Additional Risk Considerations
Certain risk factors below discuss the risks of investing in Private Markets Investment Funds.
Real Estate Securities Risks. The value of companies investing in real estate is affected by, among other things: (i) changes in general economic and market conditions; (ii) changes in the value of real estate properties; (iii) risks related to local economic conditions; overbuilding and increased competition; (iv) increases in property taxes and operating expenses; (v) changes in zoning laws; (vi) casualty and condemnation losses; (vii) variations in rental income, neighborhood values or the appeal of property to tenants; (viii) the availability of financing and (ix) changes in interest rates. Many real estate companies utilize leverage, which increases investment risk and could adversely affect a company’s operations and market value in periods of rising interest rates.
REIT Risk. There can be no assurance that the entities in which the Fund invests with the expectation that they will be taxed as a REIT will qualify as a REIT, and such a failure could significantly reduce the Fund’s yield on that investment.
Derivatives Risk. The Fund and certain Investment Funds may invest their assets in derivatives, such as futures, forwards and options contracts, which may be illiquid and have the risks of unlimited losses of the underlying holdings due to unanticipated market movements and failure to correctly predict the direction of securities prices, interest rates, and currency exchange rates.
Credit Risk. There is a risk that debt issuers will not make payments, resulting in losses to the Fund, and default perceptions could reduce the value and liquidity of securities and may cause the Fund to incur expenses in seeking recovery of principal or interest on its portfolio holdings. Lower quality bonds, known as “high yield” or “junk” bonds, present a significant risk for loss of principal and interest and involve an increased risk that the bond’s issuer, obligor or guarantor may not be able to make its payments of interest and principal.
Restricted and Illiquid Investments Risk. Particular investments of the Fund or Investment Fund may be difficult to sell at an advantageous price or at all, possibly requiring the Fund or Investment Fund to dispose of other investments at unfavorable times or prices to satisfy its obligations. Investment Funds with principal investment strategies that involve securities of non-traded REITs, companies with smaller market capitalizations, derivatives or securities with substantial market and/or credit risk tend to have the greatest exposure to liquidity risk.
Private Markets Investment Funds. The portfolio companies in which the Private Markets Investment Funds may invest also have no, or relatively short, operating histories, may face substantial competitive pressures from larger companies, and may also rely on a limited number of key personnel. Additionally, there will generally be no readily available market for the Master Fund’s investments so valuations are difficult and may not necessarily reflect the value of any such investment’s underlying assets. The Adviser may face a conflict of interest in valuing investments that lack a readily accessible market value as the value of the assets held by the Fund will affect the compensation of the Adviser. The 1940 Act provides certain protections to investors and imposes certain restrictions on registered investment companies, none of which will be applicable to the Master Fund’s investments in Private Markets Investment Funds.
Competition. The business of investing in private markets opportunities is highly competitive, uncertain, and successfully sourcing investments can be problematic given the high level of investor demand. There are no assurances that the Master Fund will be able to invest fully its assets or that suitable investment opportunities will be available.
Distressed, Special Situations and Venture Investments. Investments in distressed companies and new ventures are subject to greater risk of loss than investments in companies with more stable operations or financial condition.
Multiple Levels of Expense. Shareholders will pay the fees and expenses of a Feeder Fund and will indirectly bear the fees and expenses of the Master Fund and accordingly will indirectly bear the fees, expenses, incentive allocations, and carried interest in the case of some of the Private Markets Investment Funds in which the Master Fund invests.
Cautionary Note Regarding Forward Looking Statements. Certain information presented in this communication may contain “forward looking statements” within the meaning of the federal securities laws, including the Private Securities Litigation Reform Act of 1995. Forward looking statements include, but are not limited to, statements concerning the Fund’s plans, objectives, goals, strategies, distributions and their amounts and timing, distribution declarations, future events, future performance, prospects of its portfolio holdings, or intentions, and other information that is not historical information. Generally, forward looking statements can be identified by terminology such as “believes,” “expects,” “estimates,” “may,” “will,” “should,” “anticipates,” “projects,” “plans,” or “intends,” or the negative of such terms or other comparable terminology, or by discussions of strategy. All forward looking statements by the Fund involve known and unknown risks, uncertainties, and other factors, many of which are beyond the control of the Fund, which may cause the Fund’s actual results to be materially different from those expressed or implied by such statements. These risks include, but are not limited to, equity securities risk, corporate bonds risk, credit risk, interest rate risk, leverage and borrowing risk, additional risks of certain securities in which the Fund invests, market discount from NAV, distribution policy risk, management risk, risks related to the negative impacts from the continued spread of COVID-19 on the economy and the broader financial markets, and other risks discussed in the Fund’s filings with the SEC. All such subsequent forward looking statements, whether written or oral, by the Fund or on its behalf, are also expressly qualified by these cautionary statements. Investors should carefully consider the risks, uncertainties, and other factors, together with all of the other information included in the Fund’s filings with the SEC, and similar information. The Fund may also make additional forward looking statements from time to time. All forward looking statements apply only as of the date made. The Fund undertakes no obligation to publicly update or revise forward looking statements, whether as a result of new information, future events, or otherwise. Thus you should not place undue reliance on forward looking statements.
The Standard and Poor’s 500, or simply the S&P 500, is a stock market index tracking the performance of 500 large companies listed on stock exchanges in the United States. It is one of the most commonly followed equity indices. It is not possible to invest directly in an index.
Normalized Price to Earnings are adjusted to remove the effects of seasonality, revenue, and expenses that are unusual or one-time influences. Normalized earnings help business owners, financial analysts, and other stakeholders understand a company’s true earnings from its normal operations.
The dividend yield, expressed as a percentage, is a financial ratio (dividend/price) that shows how much a company pays out in dividends each year relative to its stock price.
The CAPE ratio is a valuation measure that uses real earnings per share (EPS) over a 10-year period to smooth out fluctuations in corporate profits that occur over different periods of a business cycle. The CAPE ratio, using the acronym for cyclically adjusted price-to-earnings ratio, was popularized by Yale University professor Robert Shiller. It is also known as the Shiller P/E ratio.
The stock market capitalization or equity market-to-GDP ratio is a ratio used to determine whether an overall market is undervalued or overvalued compared to a historical average. The ratio can be used to focus on specific markets, such as the U.S. market, or it can be applied to the global market, depending on what values are used in the calculation. It is calculated by dividing the stock market cap by gross domestic product (GDP).