Whatever questions arise about the increased noise around private markets – aka "alternatives" – the reality is that investors have shrinking choices in public, listed markets, which raises the need to find ways to get a piece of the business pie. This is the second part of an analysis of this area by our US correspondent.

Although a backlash may be brewing as purveyors of alternative investments step up their marketing assault on the retail market, family offices and the UHNW market remain safe havens for the asset class, albeit with considerable caution. 

“We remain optimistic that private investing will deliver outsized returns over public markets, although we are monitoring the evolution of the space,” said Jack Ablin, chief investment officer and founding partner of Chicago-based multi-family office Cresset.

While alternatives account for an estimated 5 per cent allocation in retail portfolios, a new survey released by BlackRock (which is heavily pushing alternative products) shows alternatives making up 42 per cent of assets in family office portfolios, up 3 per cent from a similar survey two years ago.

At WE Family Offices, where the “average family” has approximately $180 million under advisement at the firm, clients may have as much as 35 per cent of their portfolios allocated to alternatives, including private investments and hedge funds, according to managing partner Michael Zeuner. A general target allocation in alternatives for Market Street Trust Company’s ultra-high net worth families, who on average have nearly $50 million under management at the firm, ranges from approximately 15 per cent to 20 per cent, said chief investment officer Marc Dizard.

While skepticism of alternatives has mounted as giant Wall Street firms escalate their marketing campaigns to sell alternatives into the retail and 401(k) retirement markets, family offices and wealth managers catering to UHNW clients continue to add private equity, private credit, hedge funds, venture capital and other non-publicly traded vehicles.

Increasing allocation
Surveys by both UBS and BNY Wealth found that just over two-thirds of family offices plan to increase allocation to private equity investments and funds, while around 30 per cent indicated that they would be increasing exposure to private debt.

"There is a huge attraction to private assets because family offices have a time horizon that's aligned," said Sinead Colton Grant, chief investment officer for BNY Wealth. "They have the ability to access and take advantage of that illiquidity premium."

Alternative investments “make sense” for UHNW investors in light of historical returns, low correlation to public market investments, public market volatility and the illiquidity premium investors receive for locking up their cash for time periods that can last 10 years or more, said WE’s Zeuner. 

Alternatives’ illiquidity premium has “reaped benefits for very tenured clients,” said Market Street’s Dizard. “But the premium isn’t just given to you. There must be the right fund and the right manager.”

Wealth managers are paying increased attention to the investment structure of alternatives, agreed Cresset’s Ablin, whose clients have an estimated average of $20 million to $30 million under management at the firm. 

“As the biggest sponsors are partners with the wirehouses to package illiquid assets into semi-liquid wrappers, dislocations could occur from the liquidity mismatch,” he noted. “Massive capital inflows into these new vehicles could create price-insensitive buyers as sponsors struggle to get capital to work.  For those reasons, we prefer middle-market private equity rather than mega-cap buyout.”

PE frustration
While private equity has remained a core investment for family offices and UHNW investors, clients have become frustrated at the lack of distributions, Zeuner said. “Net asset value is not keeping up with public markets,” he explained. “It’s hard to stay committed.”

Market Street’s Dizard similarly noted that investors may have to get used to receiving a lower premium from private investments compared with public markets. “As private markets have grown and more capital is chasing the same returns,” he said, “investors will be asking is the opportunity cost still worth it?”

Family offices surveyed by BlackRock also complained that private equity comes with middling valuations, a lack of transparency and delays in returning capital. Nearly 75 per cent of family offices said private market fees are too high.

Private credit’s turn
Not coincidentally, private credit has emerged as one of the hottest – and most hyped – sectors in the alternatives market. Private credit loans have grown at an average annual rate of over 20 per cent over the last five years and now account for 7 per cent of the credit to non-financial corporations in Noth America, according to the International Monetary Fund. 

UHNW clients are increasingly attracted to private credit’s potential to diversify portfolios and the potential of higher yield than in public bond markets, and private credit now accounts for 15 per cent to 30 per cent of some family office’s portfolios, according to the BlackRock report.

By all indications, private credit will be a “broader, larger and a core part of a private client portfolio” going forward, Alona Gornick managing director and senior investment strategist for Churchill Asset Management, told Family Wealth Report.

But the IMF has warned that the rapid growth of private credit may lead to a deterioration in pricing as well as weakened deal terms, including lower underwriting standards and weakened covenants, raising the risk of credit losses in the future.

New reality
Due diligence and access to top quartile funds will be key to success in the alternatives market going forward, industry executives said.

“The concern is that the market may be bifurcated,” said Dizard. “Investors may think they are accessing one part of the market when actually they are accessing something different.”

While some investors “may get out over their skis” when making alternative investments, Zeuner noted, they need to focus on the “the right general partner who can offer value added. It’s important to stay committed and not throw the baby out with the bath water.” 

Even putting potentially higher yields aside, the reality is that options in the public markets are shrinking. The listed equity market has been contracting significantly for two decades, as companies are increasingly staying private.

Industry observers note that the alternative sector has not been through a major recession. When done right however, privately owned firms, depending on their alignment of incentives, can be among the most resilient, as demonstrated by several German firms that have been the backbone of that country's impressive post-war economic success.

As Marc Rowan, CEO of asset management giant Apollo Global Management said at last week’s Morningstar Investment Conference, “Why are we so pig-headed to think the products of today will exist in their current form for the next 20 years?”