Investors, who three decades ago relied on a mix of cash and bonds to get a 7% return, later turned to “a balanced portfolio of stocks and bonds” to get the same result, says Andrew Schuler, investment managing director for Pittsburgh-headquartered PNC Private Bank, highlighting how investment has changed in his 30-year career.
Looking forward, Schuler says clients looking to achieve the same return level should incorporate alternative investments, a broad term for non-standard categories like private equity or venture capital, which don’t fall under traditional bonds, cash or stocks, into their portfolio mix. With companies staying private longer at attractive entry-point valuations, it’s a good time for investors who haven’t incorporated alternatives into their portfolios to do so.
A recent list of top 2023 investor themes from PNC Insights specifically highlighted private-market opportunities noting that “elevated recession risk creates a more attractive entry point into private investments, as valuations have declined back to long-term averages.”
Schuler says a softer or harder recessionary environment doesn’t change his long-term view on alternatives as they’re not totally dependent on the state of the economy.
“It may adjust the entry point a little bit,” he says. However, he expects entry points will be higher in the future, making now an enticing time to invest.
Schuler also notes that those who want their investments to reflect beliefs or values can find opportunities in this space. “This new generation of investors want to make an impact,” he says. “As such, you are seeing more alternative investment offerings in the responsible investing area.”
But investing in alternatives requires careful consideration and planning, as there are unique considerations ranging from broader portfolio goals, to issues of liquidity and taxes to consider.
Schuler spoke with Penta about what investors need to keep in mind as they put money to work in alternatives.
Target a Diversified Alternatives Portfolio
Even in the alternatives space, investors want to target building a highly diversified portfolio over time like they would with equities, Schuler says. Ultra-high-net-worth clients often take “a fairly diversified approach in both the private markets and the hedge fund space.”
Schuler says for investors starting with a single investment, it’s necessary to go in with a strategy in place; it’s not enough to enter one highly targeted investment.
“Begin with a diversification plan,” he says, advising clients to invest in “either a fund vehicle that will give you that diversification, or a plan to stagger investments over time to build a diversified portfolio.” Investors who want to increase their targeting with specialized funds should do this to augment their broader portfolio once diversification is achieved.
Investors also need to consider tax treatments, for instance if their investment involves a K1—a strategy where the entity passes tax liability to its investors. He says this structure can surprise investors who have not previously encountered it.
Two other surprises some investors encounter are potential liquidity issues and the inability to get instant valuation, unlike the up-to-date pricing investors get in public markets.
Reallocate Strategically to Achieve Desired Returns
“Our return expectations for the public markets are a little muted,” Schuler says. “But by integrating alternatives into a portfolio, you can still achieve that target return at a lower level of risk.”
Critical to this is determining, alongside an advisor, what role investors want alternatives to play in their portfolio. Depending on if their goals include mitigating risk, enhancing returns and dampening volatility, or maximizing returns with little concern to volatility risk, their strategy will shift.
Schuler says this is an essential consideration for investors reallocating funds from existing investments. For instance, those looking to mitigate risk might re-allocate from fixed income, while those seeking balance may do so from fixed income and either cash or equity. Purely return-seeking investors, he adds, would likely want to reallocate from equity portfolios.
He adds that even though investing in alternatives can help shift their risk profile, it doesn’t exempt them from shortfall risk or liquidity issues due to the nature of the investments.
Access Opportunities Early Through Private Placements
For investors interested in emerging technologies, it’s becoming increasingly critical to invest in alternatives.
“If you were looking for new opportunities in emerging industries, it’s not that you can’t get them in the small company space,” Schuler says, but the shifting market mix means an expanded universe of these opportunities exists in alternatives, especially in private markets.
Over the last 15 to 20 years, he notes, the number of listed companies has dropped “dramatically.” According to calculations by Jay R. Ritter of the University of Florida’s Warrington College of Business, between 1980 and 2000 there were 6,519 IPOs, while between 2001 and 2022 there were only 2,607. Furthermore, the median age of a company at IPO was six years in 1980, but in 2021 it was 11.
“Whereas, you have over 5 million private companies,” he says, some of which bring in revenues rivaling their public counterparts.
Schuler says PNC Private Bank clients are interested in private equity investments to get exposure in emerging healthcare areas as well as emerging climate and energy technologies.
Credit: marketwatch.com