There Are Now More PE Funds Than McDonald’s Franchises. What’s Behind the Alts Explosion?

What’s one thing Americans love more than their local McDonald’s? Apparently, private equity.

There are now more private-equity funds in the US (19,000) than franchises of the iconic fast-food chain (14,000), which has investors asking why they’re settling for an order of fries when they can own the whole potato farm. PE and venture capital assets now account for roughly 12% of investments in the US, a meteoric rise from their meager beginnings in the 1990s. To meet demand, asset managers are coming up with new products that are blending traditional portfolios with platform models, sometimes including alternatives alongside publicly traded assets. Meanwhile, advisors are trying to keep up with new opportunities, and understand the risks, as looser regulations — like proposed legislation that could allow alternatives into 401(k)s — loom on the horizon. 

“It’s new to a lot of advisors, and there’s a little bit of a misconception,” said Jeremy Held, managing director at Bow River Capital. “There’s a justified fear about what happens if we go from 0 to 60, and you have too much money chasing too few ideas?”

Would You Like to Supersize That?

Private markets can offer oversized returns and give clients exposure to areas of the economy that aren’t available on public exchanges, like private equity, credit, real estate, and infrastructure. In fact, more than nine in 10 advisors plan to maintain or increase their allocations to alternatives, according to a recent iCapital survey, with new structures, like evergreen or tender-offer funds, hitting the market. Clients can benefit from the premium of locking up assets long term, especially when they’re setting up financial plans that stretch out decades. “Do clients need 100% of their assets to be 100% liquid, 100% of the time?” Held said. “The answer to that is no.”

Interval funds are another popular option. Vanguard recently teamed with Blackstone to wrap public and private investments into a single product, following a similar announcement from KKR and Capital Group. Interval funds allow for quarterly redemptions and can ease clients into long-term strategies. Keep in mind, it may take years to fully recoup that money, since redemptions are usually capped at about 5% of the fund’s assets per quarter. “It could take some time under an extreme duress situation,” said Michael Perini, a portfolio manager at Catalyst Perini Strategic Income. “But I would argue that the interval fund protects us from our worst-case scenario, which would be having to sell those less liquid assets.”

With more options than ever, advisors have their work cut out trying to find the best products. The Securities and Exchange Commission made it clear that advisors will have to take increased care when selecting more complex products, sending out a bulletin in 2023 cautioning advisors to vet products for fees, risk, liquidity and even tax implications. But there is no cookie-cutter process to figure out which products are best, said Peter McGratty, executive director of RIA development at Verdence Capital. What advisors need most is help with that due diligence and selection. “They’re basically saying you’re responsible for that,” McGratty said. “The buy side for RIAs? I talked to them, and that’s the part they’re most terrified of.”

Can I Interest You In a Bridge? The private markets can take on a host of different shapes and sizes, simply because there are more private companies than public ones, and much more variability in terms of size, quality and fundamentals. “Demand for access to high-quality alternative investments among financial advisors and their clients continues to grow,” said Dan Vene, co-founder of the alts platform iCapital. “But, there’s no one-size-fits-all approach.” The first step in the learning curve is understanding the structure, he said. Start with a crash course in the different categories, like private equity, private credit, private real estate and infrastructure, and their sub-categories, including venture capital, growth and buyout. 

Still, advisors and their clients can often shy away from long lock-up periods and limited liquidity, not to mention the high investment minimums that literally disqualify the vast majority of Americans. For Vene, liquidity, in particular, has been one of the tougher hurdles. “While we are making great progress in this area, it is always necessary to properly educate advisors and their clients about the worst-case scenario in relation to liquidity,” he said. “It’s critical to appreciate that one cannot capture the ‘illiquidity premium’ in a fully liquid product.” 

While the major “food groups” are private equity, venture capital, real estate and infrastructure, the latter is probably the least understood by advisors, Held said. Traditionally, infrastructure involves large assets like energy, transportation and power, funding major projects including airports and electrical power plants. Those investments, however, often come with multi-billion-dollar price tags and exclude the vast majority of investors. In fact, only about 20 of the largest global companies participate, Held said. 

Now, more resilient segments are emerging, like road maintenance and compliance, that operate outside of the normal credit cycles. These infrastructure projects could be a way for advisors to enter into deals on a smaller scale and invest in projects that are closer to their communities. “It’s not whether the economy is growing or not,” Held said. “You have to get the road maintenance done.”

Don’t Go Out in Public. With the rise of private equity and venture capital investing, companies are also staying private longer meaning some of the best investment options are off the table for most clients. In fact, over the past two years, there has been a widening gap in quality between large-cap and small-cap stocks, including in returns on assets, returns on equity, net margin and debt-to-capital ratios, according to a Morningstar analysis. It’s forcing even the most skeptical advisors to at least kick the tires on private funds.

For advisors, private markets are still in the early innings, meaning getting up to speed on the different options is priority No. 1. Adoption will eventually come as advisors learn more about the complexities and opportunities in private assets, Held said, starting by asking major alternative asset management firms for more information (although they may have a literal bridge to sell you). Certain consultants, and general financial press, are other good options. And remember, it took the industry a decade to adopt ETFs; adding a completely new asset class is going to be much more challenging. “No one likes when the answer is, ‘You need to do homework,’” Held said. “Unfortunately, it’s just going to take time to get up to speed.”