The Case for Integrating Private Market Alternatives

The investment landscape is defined by evolution, brought on by a long list of structural and strategic innovations. Where uncertainty and volatility once were managed through a reasonably straightforward portfolio balance of public stocks (60%) and bonds (40%), integrating private market alternatives is gaining traction among investors seeking to build and preserve wealth. One reason for the rising adoption is the growing list of private market asset options available to accredited investors. As of 2022, 14.5% of client assets in wealth management portfolios were allocated to alternatives, up from about 1-5% in 2000.¹ Before then, alternative investments were primarily the domain of institutional investors, like large university endowments and pension funds.  

Increased access is a primary driver behind the growing number of individual investors diversifying their portfolios with alternatives. Emerging alternative vehicles like Evergreen funds have opened private market investing to approximately 24.3 million Americans (18.5% of the total population) – more than the number of people living in Australia.  

The ability to make informed decisions is another driving force behind the rise of alternatives. As private markets have matured, advisors and investors can see the potential for higher returns, flexibility, and security from performance data accumulated over time. More than 20 years of economic and market context offer a good sense of how alternatives can help to mute fluctuations brought on by externalities like varying interest rate environments, economic headwinds, and regulatory changes. ‍

The Evolving Private Market Landscape 

While institutional investors and university endowments have been active in the private market for decades, individual investors have only really gained access since the turn of the century. Specifically, three historical 'events' shaped the public markets and impacted how investors have come to integrate the private markets into their financial strategies: 

• The Lost Decade (2000-2009)  
• The Great Financial Crisis (2007-2009) 
• Regulatory Pressures (2002-2012) 

In the early 2000s, challenging market conditions and regulatory pressures hit simultaneously. The confluence of those external factors shifted portfolio diversification strategies and positioned private market investments as attractive options for individual investors. ‍

The Lost Decade and Global Financial Crisis 

Alternative private market asset classes, including Venture Capital (VC), Hedge Funds, and Private Equity (PE), flourished in the 1990s, generating great returns for institutional investors and super-affluent families. In March 2000, the dot com bubble burst. The S&P 500 Index peaked at 1,527.46, then began a rapid decline as investors lost confidence in technology stocks. That event defined the start of The Lost Decade, which lasted until 2009. The period was defined by flat U.S. stock market returns – the S&P 500 ended the decade at roughly the same level it began. The 9/11 attack in 2001 contributed to the challenging market as the event raised the temperature of economic uncertainty and created a brief recession. Equities recovered by the mid-2000s, then saw all gains evaporate. In 2007, the Global Financial Crisis (GFC) began, leading to a mortgage crisis and the collapse of major financial institutions. By 2010, the U.S. had experienced a full decade of severe economic contraction. Most investment portfolios were stagnant or experiencing negative growth, with very little return on equity investments. 

‍Regulatory Changes Reshape and Open Private Market Investing 

During this economic turmoil, the country experienced a host of major corporate scandals, including Enron and WorldCom. To address economic volatility and issues with corporate misconduct and to attempt to reinject investor confidence, Congress launched what has become a three-legged regulatory stool: the Sarbanes-Oxley Act in 2002, the Dodd-Frank Act in 2010, and the JOBS Act in 2012. 

The Sarbanes-Oxley Act (SOX) addressed gaps in corporate governance, transparency, and accountability – helping to restore investor and market confidence. The legislation set stringent requirements for financial reporting, internal controls, and corporate governance. In effect, these actions raised the bar for publicly traded and private companies. 

Then, in 2010, Congress followed up with the Dodd-Frank Act. Coming on the heels of the GFC, the legislation addressed systemic financial risks in an attempt to prevent another economic meltdown. Effectively, Dodd-Frank limited banks' ability to invest in private companies and funds. The Act fundamentally reshaped the lending landscape. 

Specifically, through the Volcker Rule, Dodd-Frank prohibited banks from proprietary trading, curbing the use of their funds for venture investing, and restricting ownership stakes in private equity and hedge funds to no more than 3%. Along with adding a requirement for banks to maintain higher capital reserves, this measure steered traditional banks away from direct investments in private companies. As banks pulled back, the demand for alternative capital sources grew. There was new space and opportunity for private markets to emerge as a primary funding channel for startups and other high-growth companies.  

As this new opportunity environment took hold, Congress enacted the Jumpstart Our Business Startups (JOBS) Act in 2012, which catalyzed private market growth. JOBS Act regulations allowed private companies and funds to raise capital directly from the public. The move launched various crowdfunding platforms, increasing awareness of the private markets. Private companies could now solicit investments from accredited and non-accredited investors publicly while staying private. Their shareholders (employees, early investors, founders) could also sell their shares before an IPO. By offering earlier opportunities to increase capital flow, realize gains, and capitalize on the value of high-potential companies pre-IPO, the JOBS Act added support to the robust private market ecosystem. The Act was a final stimulant for a private market environment that now offers a growing list of benefits to founders, investors, and advisors. ‍

The Private Market is a Hotbed of Value Creation 

In the years since the early 2000s, regulations, economic factors, and expanded access for investors have all prompted the growth of the private market. So has the pace of technological advancement. In the same timeframe as SOX, Dodd-Frank, and The JOBS Act, Web 1.0 laid the foundation for the Internet, which gained ubiquity and enabled the emergence of Web 2.0 (interactive, social). That facilitated the explosive growth of social and e-commerce sectors, changing how businesses and individuals do almost everything. The chain of revolutionary technology has continued to stretch, filled with companies seeking to innovate offerings and find the capital to monetize those advancements. 

Factors like access to various capital types and low borrowing rates in the past 20 years have prompted more and more of these high-growth innovation businesses to remain private. Today, the number of companies growing value in the private market is over six times more than in the public sector. Using a general metric of company maturity as a framework, the count of public companies with annual revenues exceeding $100M in the U.S. is 2,800 – comparatively, the count of private companies of that size is 19,000.² Approximately 60% of those businesses are considered 'innovation companies' (e.g., technology, life sciences). These companies operate in disruptive sectors and work to reshape industries – making them attractive to investors seeking involvement in companies driving growth and change. ‍

Investing in the Innovation Economy  

A result of the blistering level of value creation in the private market is that, if or when a company goes public, it's significantly more mature and larger. The price that the public pays at IPO or post-IPO is often substantially higher than it was valued in the private markets, often leading to price declines. Facebook (Meta) offers a case study for this trend. The company went public in 2012 with a market cap of $104B. It lost value within three months and took almost 15 months to regain its original IPO value. While the Facebook IPO was more than a decade ago, the trend remains – between 20-40% of high-growth companies gain most of their value in the private market and then experience a decline at or soon after their IPO.³ The issue is particularly true for innovation companies that scale quickly early on.  ‍

The Innovation Economy Asset Allocation Mix  

The main takeaway is that investors stand to capture more reward by putting capital into high-growth, high-potential innovation companies while still private. That's one of the reasons why growing numbers of investment experts and advisors now recommend a 50/30/20 stock-bond-alternatives portfolio. The model proposes allocating 50% of a portfolio to equities (stocks) for growth, 30% to fixed income (bonds) for security, and 20% to alternatives for the potential of risk-adjusted returns. This model replaces the traditional 60/40 portfolio composition that worked well before the 2000s when interest rates were falling and equity valuations were rising. Since then, persistently low rates and volatility in the bond and stock market have forced investors to rethink that correlation and balance. To improve portfolio resiliency and performance through diversification and to give investors more access to the massive number of high-potential companies growing value in the private market, over 60% of advisors now allocate between 6% and 25% of their clients' portfolios to private market assets. Of those who are not yet integrating alternatives, 85% plan to do so.⁴  

Among the alternatives most attractive to investors seeking value from the innovation economy, Private Equity (PE) and Venture Capital (VC) are particularly attractive alternative asset classes. PE funds tend to invest in more mature companies, acquiring controlling stakes to enhance operational efficiency or scale the business before exiting through a sale or IPO. These funds are known for delivering solid long-term returns. They are good options for long-term investors who can accept illiquidity in exchange for the potential of attractive risk-adjusted returns relative to public equities. 

Even more attractive to investors seeking to participate in the innovation economy, VC funds are ideal for investors seeking the potential of high returns. These vehicles tend to target more early-stage, high-growth companies – especially in innovation sectors. They often make investments before companies reach profitability, offering significant upside potential.   ‍

Emerging Evergreen Funds 

Within this class of alternative assets, the Evergreen fund category is getting attention because it allows Accredited Investors (not just ultra-HNWIs with the capital to qualify to invest in traditional VC funds). These funds also grant immediate market entry and access to high-growth private companies. Evergreen funds unlock access to alternatives for the 24.3 million Americans who meet the qualifications to invest: earn at least $200,000 annually ($300,000 for couples) or have a net worth of over $1 million, excluding primary residence.⁵ 

Besides widening the number of individual investors who can participate in the private market alternatives, Evergreen private equity vehicles require lower minimum investments than traditional VC and PE funds and exceptional flexibility. Continuous capital recycling and reinvestment opportunities balance returns and liquidity over time, making these structures ideal for long-term private market exposure. The ongoing access to high-growth assets also allows investors to build diversified portfolios gradually over time. All these benefits make Evergreen funds especially compelling for long-term investors seeking to augment traditional funds and tap into the potential for outsized returns with reduced volatility over time.  ‍

Making the Case for Alternatives 

For advisors and the investors they guide, private market alternatives offer several significant advantages that have made them essential additions to modern portfolios – if not the cornerstone of strategic wealth management. They can help to mute volatility, capture higher returns, open access to new investors, and align with long-term financial objectives. Not least, these vehicles provide individuals with the greatest chance to participate in the innovation economy – by investing in some of the most compelling, positively disruptive, high-impact companies in the marketplace.  ‍

Learn more about investing in the private market, the widening alternatives asset variety, and Evergreen Funds during one of our monthly educational webinars. Find the dates and registration here.

Endnotes

1. ‍Asset Allocation and Portfolio Management: Is the Industry Shifting to a New Paradigm?, CFA Institute, 2012
2. Private Market Investing: Staying Private Longer Leads to Opportunity, Hamilton Lane, April 2022
3. Initial Public Offerings: Updated Statistics, Ritter, J. R., University of Florida, 2020
4. CAIS - Mercer Survey Finds Advisor Demand Accelerating for Alternative Investments, CAIS, 2023
5. Definition of an Accredited Inveestor, Securities and Exchange Commission