Private Markets: 4 steps to help you optimize your allocation to alternatives
Individual investors often first get involved in alternative investments through ad hoc, one-off opportunities—or by searching in specific asset class silos (i.e. real assets, private equity, private credit and hedge funds.)
Even the savviest family offices and pensions often start investing in alternatives on a fairly limited basis: by focusing on a single objective; be it enhanced returns or yield, volatility mitigation or inflation protection.
But alternative asset classes and strategies have historically proven their worth. We believe traditional markets alone may be unlikely to provide the return, income and diversification that many investors seek. And the universe of alternatives has expanded offerings so that it now provides investors a robust toolkit.
Clearly, if you’re going to invest in alternatives, it’s time to build a thoughtful strategy around your allocation. The challenge, of course, is how to accomplish this feat.1
Here, we provide a quick look at our four-step approach to constructing an alternatives portfolio plus some insights from our experienced specialists to help light the way—so that your investments might more effectively help you reach your goals.
1. Identify your investment portfolio objectives.
To us, building an alternatives portfolio starts with defining the outcome(s) you seek so you can properly identify what approach(es) might help you succeed.
So what do you hope to accomplish? There are generally two main categories investors look to solve for: diversification and return enhancement.
Given those goals, the choice of investments is sometimes clear, as some alternatives have a distinct, primary function in a portfolio; for example, private equity can be a source of enhanced returns.
However, other categories have multiple functions. Private credit, for instance, can provide inflation protection, yield and enhanced returns.
Also, while the broad array of investments provides investors great flexibility, it also necessitates an added level of scrutiny, experience and monitoring to uncover all the underlying attributes of each asset class and opportunity.
2. Right-size your alternative investment allocation.
The next critical question for those who already are invested in alternatives: How much capital should I put, in total, to work in the private markets?
The typical range we’ve seen among private bank clients is 15% to 30% of their overall portfolio. That said, some clients with significant resources and an inclination to plan multi-generationally do allocate 50% or more to alternatives; much like some large endowments.
Carefully consider how much you might allocate to help you achieve your particular goals. As part of that decision process, we can help you evaluate your:
- Tolerance for illiquidity and time horizons—The size of your commitment depends in great part on your liquidity needs, as alternatives are by definition less liquid than public market investments; alternatives investors trade liquidity for return potential.
However, this market has been developing, and opening, to such a degree that it’s time to dispel the notion that you can allocate to alternatives only if you’re willing to lock up your capital for seven or more years. In fact, alternatives now offer a variety of time horizons.
Some alternative investments (such as business development companies (BDCs), non-traded REITs and hedge funds) offer monthly and quarterly liquidity2. This liquidity profile often creates an ability to borrow, should that suit your needs. Indeed, you may be able to as much as get 35% to 50% lending value against such holdings.
- Existing allocation to alternatives. Before setting a course for new investments, you’d also be wise to look at not only your current investments in alternatives but also at all the assets on your balance sheet. If, for example, you have a private business, you might want to count your investment in it as part of your allocation to alternatives (as your business is a private enterprise and your investment in it is likely to be not only locked-up for but also long-term.)
3. Build a diversified alternatives portfolio.
We strongly recommend diversifying your alternatives portfolio itself and suggest doing so along key factors such as geographic exposure, manager selection and vintage year—as well as liquidity and strategy.
The need to diversify geographically is often obvious; across managers, sometimes less so. Yet, in any industry that has higher fees, less liquidity, and less transparency, you want to be careful. Exercise robust due diligence in choosing managers and make sure your manager roster is well-diversified.
As for vintage year diversification: Investors tend to over-over-allocate at the onset, because they want to ramp up. But one of the most important diversification strategies is to take a consistent, measured approach by allocating over multiple vintage years. You want to sustain your exposure and it’s difficult to know which future year is going to be provide the best opportunity.
For example, think about the outbreak of COVID-19. Imagine the chagrin of investors who’d only invested in vintage year 2017, so that all their capital was put to work by 2020 and they couldn’t take advantage of the COVID-19-generated dislocation but they did have a great deal of exposure to COVID-19’s outcome.
We believe the way to truly optimize your allocation is to allocate consistently.
Our advice: Consider investing in no less than three vintage years. Many sophisticated investors strive to commit evenly over four to five years and to recycle capital thereafter.
Given the lifecycle of some alternative investments and how critical the timing of vintages is, we suggest that, if you want to get to, say, a 30% allocation to alternatives in your portfolio, you might consider investing only a portion, about 7% or 8% a year. You’d keep that pace until you get to your desired allocation—then refill the funnel as investments realize over time.
4. Pick the right partner.
To pick the right partner, you need access to information about the managers running the investment as well as access to investment opportunities themselves.
The alternatives universe is vast (it now includes more than 18,000 private investment funds and 9,000-plus hedge funds alone).3 Evaluating and monitoring offerings is time consuming and complex, but critical as performance can vary widely. For example: on average, there has been a 21 percentage point difference between performance of top-quartile and bottom-quartile private equity managers and a 13 percentage point difference between top-quartile and bottom-quartile hedge fund managers.4
Many clients choose to work with us because of our rigorous scrutiny of managers. Our in-house team conducts on-site visits and we examine, among other factors, the structure, operations, incentives, and individuals on a manager’s team.
But we also offer access to funds that our global investment strategy team, drawing on our size and scale, creates with select partners.
We can help
Even the most experienced investors can easily be overpowered by the array of alternative classes, strategies, and vehicles now on offer. And all the information in the world is not useful unless it is applied to an individual’s particular circumstances.
We are committed to working with our clients to help them explore all the ways they might achieve their long-term objectives.
For a thoughtful analysis of what steps you might want to take and when, your J.P. Morgan team and our alternative investments specialists are available for consultation.
Investing in alternative assets involves higher risks than traditional investments and is suitable only for sophisticated investors. Alternative investments involve greater risks than traditional investments and should not be deemed a complete investment program. They are not tax-efficient and an investor should consult with his/her tax advisor prior to investing. Alternative investments have higher fees than traditional investments and they may also be highly leveraged and engage in speculative investment techniques, which can magnify the potential for investment loss or gain. The value of the investment may fall as well as rise, and investors may get back less than they invested. Diversification and asset allocation does not ensure a profit or protect against loss.
As a reminder, hedge funds (or funds of hedge funds) often engage in leveraging and other speculative investment practices that may increase the risk of investment loss. These investments can be highly illiquid, and are not required to provide periodic pricing or valuation information to investors, and may involve complex tax structures and delays in distributing important tax information. These investments are not subject to the same regulatory requirements as mutual funds; and often charge high fees. Further, any number of conflicts of interest may exist in the context of the management and/or operation of any such fund. For complete information, please refer to the applicable offering memorandum.
This material is for informational purposes only, and may inform you of certain products and services offered by J.P. Morgan’s wealth management businesses, part of JPMorgan Chase & Co. (“JPM”). Products and services described, as well as associated fees, charges and interest rates, are subject to change in accordance with the applicable account agreements and may differ among geographic locations. Not all products and services are offered at all locations. If you are a person with a disability and need additional support accessing this material, please contact your J.P. Morgan team or email us at firstname.lastname@example.org for assistance. Please read all Important Information.
GENERAL RISKS & CONSIDERATIONS. Any views, strategies or products discussed in this material may not be appropriate for all individuals and are subject to risks. Investors may get back less than they invested, and past performance is not a reliable indicator of future results. Asset allocation/diversification does not guarantee a profit or protect against loss. Nothing in this material should be relied upon in isolation for the purpose of making an investment decision. You are urged to consider carefully whether the services, products, asset classes (e.g. equities, fixed income, alternative investments, commodities, etc.) or strategies discussed are suitable to your needs. You must also consider the objectives, risks, charges, and expenses associated with an investment service, product or strategy prior to making an investment decision. For this and more complete information, including discussion of your goals/situation, contact your J.P. Morgan representative.
NON-RELIANCE. Certain information contained in this material is believed to be reliable; however, JPM does not represent or warrant its accuracy, reliability or completeness, or accept any liability for any loss or damage (whether direct or indirect) arising out of the use of all or any part of this material. No representation or warranty should be made with regard to any computations, graphs, tables, diagrams or commentary in this material, which are provided for illustration/reference purposes only. The views, opinions, estimates and strategies expressed in this material constitute our judgment based on current market conditions and are subject to change without notice. JPM assumes no duty to update any information in this material in the event that such information changes. Views, opinions, estimates and strategies expressed herein may differ from those expressed by other areas of JPM, views expressed for other purposes or in other contexts, and this material should not be regarded as a research report. Any projected results and risks are based solely on hypothetical examples cited, and actual results and risks will vary depending on specific circumstances. Forward-looking statements should not be considered as guarantees or predictions of future events.
Nothing in this document shall be construed as giving rise to any duty of care owed to, or advisory relationship with, you or any third party. Nothing in this document shall be regarded as an offer, solicitation, recommendation or advice (whether financial, accounting, legal, tax or other) given by J.P. Morgan and/or its officers or employees, irrespective of whether or not such communication was given at your request. J.P. Morgan and its affiliates and employees do not provide tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any financial transactions.
Legal Entity and Regulatory Information.
J.P. Morgan Wealth Management is a business of JPMorgan Chase & Co., which offers investment products and services through J.P. Morgan Securities LLC (JPMS), a registered broker-dealer and investment adviser, member FINRA and SIPC. Insurance products are made available through Chase Insurance Agency, Inc. (CIA), a licensed insurance agency, doing business as Chase Insurance Agency Services, Inc. in Florida. Certain custody and other services are provided by JPMorgan Chase Bank, N.A. (JPMCB). JPMS, CIA and JPMCB are affiliated companies under the common control of JPMorgan Chase & Co. Products not available in all states.
Bank deposit accounts and related services, such as checking, savings and bank lending, are offered by JPMorgan Chase Bank, N.A. Member FDIC.
This document may provide information about the brokerage and investment advisory services provided by J.P. Morgan Securities LLC (“JPMS”). The agreements entered into with JPMS, and corresponding disclosures provided with respect to the different products and services provided by JPMS (including our Form ADV disclosure brochure, if and when applicable), contain important information about the capacity in which we will be acting. You should read them all carefully. We encourage clients to speak to their JPMS representative regarding the nature of the products and services and to ask any questions they may have about the difference between brokerage and investment advisory services, including the obligation to disclose conflicts of interests and to act in the best interests of our clients.
J.P. Morgan may hold a position for itself or our other clients which may not be consistent with the information, opinions, estimates, investment strategies or views expressed in this document. JPMorgan Chase & Co. or its affiliates may hold a position or act as market maker in the financial instruments of any issuer discussed herein or act as an underwriter, placement agent, advisor or lender to such issuer.
© 2023 JPMorgan Chase & Co. All rights reserved