The risk of asset bubbles bursting is all around us. Valuations in public equity markets have not been higher since the peak of the internet bubble in 2000. It seems that everyday there are new negative yielding sovereign bonds issued by national governments. Rates on certificates of deposits are at all-time lows. Real estate prices have ballooned all over the country, pricing out many would-be homebuyers as large firms like BlackRock have jumped into the residential real estate market. One of the best charts to quickly summarize the current state of affairs in the investment markets is the chart below, as compiled by Bloomberg and Deutsche Bank.
The chart above clearly lays out that 85% of all US high-yield “junk” bonds have a yield that is currently below the current rate of U.S. inflation. That is a big deal. 85% of the public bonds that are currently on the market are losing money when adjusting for inflation, meaning the public bond market should be effectively dead for most U.S. private investors. These investors are taking all the risk of investing in non-investment grade assets but are effectively losing money from the moment of “investment.”
Globally, the amount of negative interest debt has increased to $18 trillion, the largest ever seen in the history of finance. Ultra-low, even negative, central bank rates have had a huge effect on the value of public equity securities, resulting in one of the longest bull markets in the history of U.S. equity markets and one of the highest valuation multiples seen in recent history.
The chart below is an excellent depiction of how to graphically see the valuation of the S&P 500 index vs. the actual profits made by those same 500 firms. You can see that from 2010 to the present corporate profits haven’t moved an inch, but the valuations of these same firms have increased more than four times over. What has really changed – why the spike in stock prices? This is the question every accredited investor should be asking themselves and the answer is likely to be: speculation, easy access to capital and a starvation for meaningful yields.
Investors in U.S. commercial real estate face a similar dilemma. Rising prices as a result of low inventory and low-cost financing is resulting in meaningless yields in the commercial real estate market. According to this data from CBRE, investors in commercial real estate face the same battle as bond investors – their investments no longer keep up with inflation and a soaring consumer price index.
Accredited Investors are Turning to Alternative Investments
So where are sophisticated U.S. accredited investors placing capital these days to counteract these clearly negative public market trends?
The answer is alternative investments.
Never before has there been so much capital invested in alternative investments through institutions and high net worth investors. At the end of last year, alternative investment managers’ combined assets under management reached an all-time high of $7.4 trillion and are forecasted to reach $17.2 trillion in 2025. The ultra-rich have led the way, and on average have allocated 50% of their portfolios to alternative investments, with a majority of this allocation going towards private equity placements. 81% of Ultra-High-Net-Worth Individuals now use alternative investments as a key portion of their investment portfolio.
Why are Sophisticated Investors so Drastically Turning to Alternative Investments?
We see five key reasons why accredited investors are finding alternative investments so attractive:
- Availability of Financial Returns: We detailed above the lack of options in today’s public markets and in the real estate sector.
- Strategic: Alternative assets offer diversification, typically have less correlation to the stock market than traditional investments and can be used as an effective hedge against increases in U.S. inflation rates.
- Changing Capital Allocation: A transition in investor preferences towards sustainable and impact-focused investments has recently occurred, to which public market options do not sufficiently cover this need.
- Regulatory Flexibility: Recent regulatory changes at the Securities & Exchange Commission (SEC) have made private placement opportunities more accessible to more investors.
- Unicorn and Large Exit Potentials: There has been a steady transition of investor preference into funding early-stage, private companies and a correlating increase in venture capital placements, again with a focus on earning higher long-term total returns.
In short, investors are looking for returns anywhere they can get them and alternative investments are delivering. Even hedge funds, who typically only deal with highly-liquid public market investments, are delving into private market transactions. These hedge funds are competing directly with private equity and venture capital funds by participating in early-stage company funding rounds. According to Goldman Sachs, faster growing, private companies are conducting more equity funding rounds before their eventual IPOs. In 2006, the median number of pre-IPO funding rounds was one. In 2021, this number has grown to three. Companies are raising more money in the private markets as well. The median funding round has increased from $30 million in 2006 to $58 million in 2021.
How to Invest in Alternative Investments
Alternative investments are not limited to institutions and ultra-high-net-worth investors.
We are seeing a tremendous amount of positive market changes that, for example, single and double-digit millionaires should be looking to take advantage of:
- Invest like the ultra-wealthy directly into portfolio companies: More and more successful private companies are raising money in the private placement markets. An investor doesn’t need to place a million dollars into a private equity fund to participate in these deals as more opportunities continue to open directly to any U.S. accredited investor. In our experience at Legacy Group, we are seeing accredited investors enter more deals than ever before with placement sizes of $50k to $250k – amounts that were typically not enough to participate when deal volume was less. Whether you are investing in seed rounds like a venture capital fund or series D rounds like a later stage private equity strategy, the ability to invest directly into private, earlier stage companies should be at the top of your mind and should provide access to superior risk-adjusted return opportunities, especially in the impact investing space.
- Early-stage company crowdfunding raises are becoming more interesting: Before the changes the SEC made to the fundraising limitations in early 2021 increasing Reg CF offerings to $5m instead of their previous $1m annual limits, the crowdfunding methodology was largely underutilized and not really attractive to most companies raising capital. With the new $5 million limit, accredited U.S. investors are getting access to many more deals. Nowadays, we are seeing many more companies using crowdfunding as a way to jumpstart their capital-raising initiatives. With the potential for further regulatory loosening on the way, this is an area of the investment world to watch.
- Look to potentially increase your exposure to alternative investments: In today’s world, we at Legacy Group think that alternative investments are the best way to prepare your portfolio for outsized returns. As partners at Legacy Group, we commit nearly 100% of our capital to alternative investments in our own portfolio companies. We can´t help but recommend that other accredited investors also take a hard look at their portfolio allocations and their exposure to alternatives. We see annual IRR potential in the 20 – 35% range for most investors in our portfolio companies, and welcome additional accredited investors looking for alternative investment exposure alongside us.
To learn more about investing in alternative investments or available investment opportunities in our portfolio companies, contact us at investor.relations@legacy-group.co.
About Legacy Group
Legacy Group is distinguished by a singular tradition of service to our portfolio partners; the mutual commitment to, and the seamless collaboration of, a true partnership; formidable financial and legal talent across multiple disciplines and jurisdictions; and shared professional values that focus on client needs.
We provide experience and investment to a wide range of private companies spanning many industries, including real estate, hospitality, tourism, agriculture and technology. Contact us to learn more and to discuss current investment opportunities available to you in our portfolio companies.
*This publication/newsletter is for informational purposes and does not contain or convey legal advice. The information herein should not be used or relied upon in regard to any particular facts or circumstances without first consulting a lawyer. Any views expressed herein are those of the author(s) and not necessarily those of our clients.
Sources:
https://pitchbook.com/newsletter/lps-issue-a-climate-change-wake-up-call-for-private-equity
https://www.pionline.com/alternatives/assets-alternative-investments-set-record-2020
https://www.fool.com/research/high-net-worth-alternative-investments/
https://www.currentmarketvaluation.com/models/price-earnings.php
https://www.cnbc.com/2021/06/23/as-inflation-fears-spike-cd-rates-hit-all-time-lows.html
https://slate.com/business/2021/06/blackrock-invitation-houses-investment-firms-real-estate.html
