Private Markets & Alternative Investments

Alternative investments have grown in popularity since their increased investor access in the 2010’s. As buzz words like private equity and private credit have been in the headlines as a flashy new investment opportunity, they provided an investment solution for folks looking for income, looking for outsized growth, or a balance for the volatility of public markets. Since these private investments have been around for decades, there are plenty of options for a range of suitability preferences with initiatives being taken to include investments with no accreditation requirement.

Private Equity: Rather than buying stock in public companies, private equity refers to buying stock in private companies. Private companies do not trade over the counter as public companies do, but have similar economics to public companies. Similarly to public companies letting investors buy shares of their companies to fund their projects, private companies allow investors to buy shares to fund their projects. These companies can be worth 10’s of millions or 10’s of billions, have negative earnings or have earnings in the billions each year.

Private Credit: Another way for a company to fund their projects or businesses is for them to borrow money. Investors can participate in lending to these companies in exchange for an interest rate which gets paid to investors as income. This interest rate is a percentage above SOFR (Secured Overnight Financing Rate). As interest rates are increased or decreased by the Fed, the lending rate may change depending on the term of the loan. Similar to a home equity line of credit, there are private credit solutions that are backed by assets or simply backed by the promise of the company. Similar to bonds, this income can be used to dampen volatility in a portfolio. The cause for concern in private credit is similar to bonds, with the main concern being the credit quality of the borrower and the probability of defaults. As such, there are portfolios that reward investors for lending to both types of companies with income higher than public credit or bond markets, with many years worth of data to support them.

Private Infrastructure: If an investor is interested in a combination of growth and income, private infrastructure invests in fiscally and operationally necessary business functions. Whether it is phone lines, data storage facilities, or airports, there are many different kinds of infrastructure. These portfolios typically include income and growth because investors give money to companies that are going to build something that will either be paid for overtime or all at once. For example, if a company built a data storage facility, the rents for use of the facility would be paid to investors. On the contrary, a company could build that facility and sell it for more than the operational cost of building it, hence the growth part.

The Risks: A lot of the private markets solutions entail what is known as illiquidity premium: the premium above a normal return that an investor should receive for forgoing the typical daily liquidity (being able to sell during market hours daily). Many alternatives are in an interval fund structure, which typically allows for investors to request to sell their shares on a quarterly basis. As we have seen in real estate funds recently, there is also the risk of gating. Gating refers to the fund managers not having to allow more than 5% of the total value of the fund to be liquidated to honor investor sell requests. Although this is a negative for investors looking to sell, the liquidity requests do get prorated depending on the total requests made and it saves the fund from having to liquidate investments within the fund that they would be forced to take pennies on the dollar for. This also protects long term investors.

Although some investments don’t require accreditation, more frequently there are requirements to be an accredited investor, qualified client, or a qualified purchaser, with each having their own income or investable net worth thresholds. For example, some funds require investors to be qualified purchasers which is characterized by having $5 million in net worth. On the contrary, other funds don’t require any accreditation.

Bickling has longer, in depth articles on Private Credit and Private Equity, in which can be sent upon request. Please reach out to an advisor to ask about the pros and cons of each investment, as well as their thoughts on including investments like these in your portfolio.