In the past, investors have been able to build a diversified, high-performance portfolio using only public assets. Over the last 30 years, a traditional ‘60/40’ portfolio invested in the S&P 500 and investment-grade bonds would have returned approximately 9.7% annualized. Because bonds provided stability against stock market volatility and prolonged bear markets, this mix tended to reduce risk.

Recent years, however, have demonstrated the limits of traditional public portfolios. In 2008, bonds failed to provide a meaningful hedge against falling stocks, resulting in a loss of 25.6% for the 60/40 portfolio. In 2022, both asset classes plunged together, leading to a 17.4% loss. For investors, these experiences were a wake-up call – public markets may no longer be sufficient to assemble a robust, diversified portfolio.

Institutional investors have long looked beyond public markets. The ‘Yale model,’ pioneered by the eponymous university’s endowment fund, calls for significant exposure to private market assets. Private markets now account for 11.5% of institutional investor portfolios. In comparison, when individual investors have any private market holdings at all, their exposure is typically less than 3%.

Historically, several factors have contributed to this underallocation. In the past, high-quality private market assets often came with excessive investment minimums and long holding periods. Moreover, understanding and analyzing these assets took considerable skill and experience. 

But today, the environment has changed. Sophisticated strategies are now available at accessible dollar levels and liquidity terms have improved substantially. While the role of skill remains, the team at Sandro Wealth has decades of experience working with advisors and clients to implement an effective and robust private market portfolio. As a result, the advantages of private market investing are no longer limited to institutions. 

In this article, we will outline the three main reasons why investors should consider building a private market allocation over time: increased diversification, greater capacity for manager selection, and the potential for higher risk-adjusted returns. 

Reason #1: Increased Portfolio Diversification 

Public markets have become highly concentrated. Although the S&P 500 is composed of stocks from 500 different companies, these firms are not weighted equally in the index. As a result, just ten firms account for 36% of the S&P 500’s value.

Not only are indexes becoming more concentrated, but the public equity universe as a whole is shrinking. Throughout the 1990s, there were about 7,000 publicly listed companies in the United States. By 2024, that figure had shrunk to around 4,500. Currently, estimates indicate that 86% of US firms with revenues greater than $100 million are privately held.

And this trend isn’t unique to stocks. As private credit continues to grow, the share of corporate lending taking place through traditional channels is shrinking. In both stocks and bonds, the ability of public-only investors to access a diversified mix of high-quality companies has deteriorated.

Private markets can offer investors access to a wider range of companies, including firms of varying sizes and growth prospects. As a result, investments in private equity and credit are imperfectly correlated to public markets. In fact, private market investments in asset classes like hedge funds or real assets can have an even lower correlation. 

This data indicates that private markets can offer diversification benefits not found in public markets. Nobel laureate Harry Markowitz, inventor of Modern Portfolio Theory, famously referred to diversification as “the only free lunch in investing.” Private markets offer a powerful opportunity to enhance diversification both within and across asset classes.

Reason #2: Opportunity to Enhance Risk-Adjusted Returns

Private markets can help improve the resiliency of an investor’s portfolio. But does this resiliency come at the expense of performance? 

No – in fact, just the opposite. Private markets have historically outperformed their public market peers. Over the past 20 years, an index of North American private equity funds has eclipsed the S&P 500 by 5.5% annualized. In the past decade, direct lending returns (the most dominant form of private credit) have been nearly double the returns of public fixed-income. 

In addition to higher overall returns, private markets also feature the opportunity to earn higher current income. In private credit, for instance, current yields are consistently higher than public bonds due to wider credit spreads. Asset classes like infrastructure and equipment leasing also offer the opportunity to benefit from diversified income sources. 

These figures are compelling. However, investors need to consider whether achieving higher returns and income is simply compensation for bearing greater risk. Based on the data, this does not appear to be the case.

Because private assets are typically valued on a fundamental basis, returns are less subject to technical factors that can distort market prices. These factors include emotions and sentiment which can skew public valuations during bear markets. As a result, private markets have exhibited both smaller drawdowns and lower volatility than comparable public market assets. 

Importantly, this risk-adjusted outperformance does not appear to be a fleeting phenomenon. There are several persuasive reasons to think that private markets should offer structurally higher returns over the long term.

First, private assets are generally harder to sell than public assets. This results in an ‘illiquidity premium’ that compensates investors for the risk that they may not be able to exit their positions quickly. Estimates of the illiquidity premium are generally around 1-3% per year, a source of additional return not found in liquid public markets.

Next, capital allocators are far more discerning in private markets. For private market fund managers, fundamentals matter in a way not always apparent in public markets. For example, public equities have recently traded at valuations that are not well supported by reasonable earnings growth expectations. 

For investors, this means that private markets offer the opportunity to earn higher risk-adjusted returns. Earning these returns, however, is not a foregone conclusion. Instead, it is highly dependent on rigorous manager selection. 

Reason #3: Greater Opportunity for Manager Selection

In public markets, there is remarkably little ‘dispersion’ in manager performance. Research from Blackstone shows that top-quartile public equity funds tend to beat bottom-quartile funds by just 1.7 points per year. Therefore, selecting high-performing managers may make only a modest difference to public portfolio outcomes. 

In private markets, however, the manager research that Sandro Wealth conducts can make a significant impact on realized returns. In private equity, top-quartile managers have historically beaten bottom-quartile ones by an astounding 15 points per year. In private credit, this figure is 5.2 points annually, compared to just 0.6 in public credit. 

Private market managers who outperform in one fund are also more likely to outperform in subsequent funds, a concept known as ‘return persistence.’ Persistence is particularly notable in asset classes like venture capital and private credit, providing evidence that strong returns are due to skill, not luck. 

The argument that private markets feature more opportunities for managers to add value is intuitive. Unlike public markets, private markets do not offer all investors access to the same information or the same opportunities. Therefore, it is possible to translate superior origination, valuation, and due diligence capabilities into stronger performance.

Conclusion: Risks Amid Opportunities

While portfolio allocation must be determined on an individual basis, many investors would likely be well-served by increased exposure to private markets. Sandro Wealth Management has decades of experience researching and investing in these markets. Our team focuses on working with advisors and clients to determine if private market investments are beneficial to achieving a portfolio’s goals. 

Private markets are not without unique risk factors. Due to greater dispersion, poor manager selection can significantly impair performance. Moreover, properly allocating between distinct private market asset classes requires a thorough understanding of their risk & reward tradeoffs. 

At Sandro Wealth Management, we specialize in helping Accredited Investors and Qualified Purchasers navigate these factors to assemble a suitable private market portfolio. In addition to our extensive experience evaluating private market managers, our cross-asset class expertise can guide investors in assembling a comprehensive private asset allocation. An experienced partner can help investors avoid the unique risks of private markets while accessing their unique rewards.

Disclaimer

Sandro Wealth Management, LLC (“Sandro Wealth”) is a registered investment advisor. Advisory services are only offered to clients or prospective clients where Sandro Wealth and its representatives are properly licensed or exempt from licensure.

The views expressed in this commentary are subject to change based on market and other conditions. These documents may contain certain statements that may be deemed forward‐looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Any projections, market outlooks, or estimates are based upon certain assumptions and should not be construed as indicative of actual events that will occur.

All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such.

Targets are estimates based on certain assumptions and analysis made by the Advisor. There is no guarantee that the estimates will be achieved.

Although bonds generally present less short-term risk and volatility risk than stocks, bonds contain interest rate risks; the risk of issuer default; issuer credit risk; liquidity risk; and inflation risk.

Diversification does not ensure a profit or guarantee against loss. Past performance shown is not indicative of future results, which could differ substantially.

Investing in private funds involves a risk of loss that each existing and prospective investor should understand and be willing to bear. Existing and prospective investors are reminded to read fully and carefully understand these risks as outlined in Offering Documents and to discuss these risks with the Advisor.

No investment strategy or risk management technique can guarantee returns or eliminate risk in any market environment. All investments include a risk of loss that clients should be prepared to bear. The principal risks of Sandro Wealth Management LLC strategies are disclosed in the publicly available Form ADV Part 2A.