A beginner’s guide to investing in the private markets

No longer reserved for institutional investors and the ultra-wealthy

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Private-market investing used to be reserved for institutional investors and the ultra-wealthy who had at least $5 million in net assets, but markets and investment products have since evolved to allow people who have even just $100,000 in savings to enter this once-rarefied realm.

One reason for the interest is that returns in the private markets don’t follow that of the public indexes — a low correlation, in other words — which is why pension funds have long aggressively pursued the asset class since they want their members to get handsome returns on their retirement money without worrying about the stock market.

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If a person took $1 and invested it in 2018, by the first quarter of this year, the value of that dollar would have grown to $1.45 in public equities, $2.30 in private equities, $1.41 in private credit and $1.60 in private real estate, according to Hamilton Lane Advisors LLC data.

Alternative assets have become more enticing and accessible over the past few years as Canadians seek ways to diversify their portfolios, but it’s a universe that’s complex and filled with numerous, varying types of investments.

Understanding the risks, benefits and features, as well as fees and redemption schedules, of private markets is one of the first steps experts say neophytes should take before investing.

But that’s a start, because investing in alternatives is still mostly reserved for those with enough money to lose and a deep level of knowledge.

What are private markets?

Private markets encompass a broad range of investments that are not traded on a public stock exchange, such as the Toronto Stock Exchange or Nasdaq, and include venture capital, private equity, private credit and real estate or infrastructure. Investing in private markets can be one way to diversify the traditional 60/40 portfolio and boost returns.

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But aside from buying a rental property, it’s historically been hard for non-accredited retail investors to enter the space due to regulatory barriers, said Marcus New, chief executive of InvestX Capital Ltd., a Vancouver-based company that offers a platform to trade shares of companies that haven’t gone public yet.

“Regulators have basically tried to keep away 97 per cent of the population from being able to invest in alternatives, which is why the ultra-wealthy continue to get ultra-wealthy,” he said.

Why is it difficult for retail investors?

Asset managers are offering more private-market products, but investing in them hasn’t reached the same level of ubiquity or ease as opening an app and swiping a finger across a phone screen to trade public stocks, which can also be done without ever having to consult a broker.

To invest in private assets, the Canadian Securities Administrators, the overarching body that covers provincial and territorial regulators, said a person must meet minimum requirements of either: alone or with a spouse, owning financial assets that are worth $1 million or more before taxes, minus any liabilities (including cash and securities); alone or with a spouse, owning net assets valued at $5 million minimum (including illiquid assets such as a house); or having a net income, before taxes, of $200,000 for the past two years, and if including a spouse, the threshold becomes a $300,000 net income before taxes for the most recent two years.

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Despite the threshold changes, institutional investors are still the biggest players in private markets. For example, Canada’s public pension funds are large holders of infrastructure, private equity and private credit, and manage 11 per cent of total Canadian-dollar assets in the financial system.

Institutional investors and ultra-high-net-worth individuals allocate 50 per cent of their portfolios to alternative investments while Canadian retail investor portfolios hold less than five per cent in alternatives, according to Purpose Investments Inc.

New said retail investors “need to tell the regulators” they’d like more access to products that sophisticated investors have because private-market offerings are growing.

“We have access to information we didn’t have back then when the rules were written. We have access to advisers today that we didn’t have back then,” he said. “It’s such a different world (now) and the regulators are really kind of out of step.”

Who should venture into the space?

One difference between public and private securities is their liquidity, which likely factors into who can and who wants to put their money in alternatives.

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Close-ended private-market funds rely on investors, known as limited partners, who have up to millions in capital to commit. Their money can be locked up for about 10 years before they see a return once the fund starts exiting the companies in its underlying portfolio.

But not all alternative investment products are that stringent on liquidity or structured that way. Some asset firms offer evergreen and open-ended funds that allow quarterly redemptions. Even then, it’s not like a public stock where there’s almost a guarantee that you can sell your shares on the open market and will find a buyer, Tyler Meyrick, head of private assets at Purpose, said.

Retail investors who can earmark a portion of their investment portfolio for the long term might want to consider private assets, he added.

“If you’re 25 or 30, and you think you want to buy a house in two years, you probably are not buying private investments because they can be difficult to quickly sell,” Meyrick said.

“But if you’re 40 and you’ve got a house, you funded your kid’s education, and you don’t think you’re going to need the bulk of your portfolio until you retire in 20 or 25 years, then some portion of your portfolio going into private investments probably makes a lot of sense for you.”

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How do you invest?

Private assets are generally less regulated than public investments and there are plenty of options in which to invest. The system is geared toward institutional and ultra-wealthy investors who are in-the-know by virtue of how much capital they have, affording them opportunities and access that one can’t get merely trading in public markets.

If a venture-capital firm isn’t knocking on your door to invest in their latest fund as a limited partner, there are other avenues.

One of the ways qualified retail investors — that is, those individuals who have net assets of at least $1 million — can get into private markets is through those evergreen and open-ended funds. A full-service broker will purchase shares on the investor’s behalf. Asset management firms may package the underlying investments into an index fund or a fund of funds. Each fund will have different fees, redemption and distribution periods, as well as minimum investments.

Meyrick said there’s a wide range of performance outcomes for each asset manager and he suggests picking blue-chip firms when beginning to invest.

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“Fees are important, but your net returns are very important as well,” he said. “You don’t want to focus, in the private markets, purely on getting the lowest-fee product because it may well not be the best performing product.”

Purpose launched three products in April: a private-equity fund, a private real estate fund and a private-credit fund. The minimum contributions range from $2,500 to $5,000 and redemptions can be made quarterly, but you still need to be an accredited investor.

The availability of exchange-traded funds (ETFs) is growing, too, after securities regulators in 2019 altered the rules to permit retail investors access to strategies deployed by institutional investors.

Meyrick said firms offer these ETFs, known as liquid alternatives, on public indexes and can allocate up to 10 per cent of the fund to private markets, though most firms tend to focus investments on public securities.

Liquid alternatives can be less risky than illiquid strategies, ETFs tend to have lower fees than mutual funds, and anyone can purchase ETFs since they trade on public exchanges.

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If you’re still not fully comfortable with private markets, you can invest in the public shares of firms that manage and deal in private assets or in funds that track them.

For example, National Bank Trust Inc. offers the NBI Global Private Equity ETF. Its top three holdings are Partners Group Holding AG, Blackstone Inc. and KKR & Co Inc. — all private-equity firms.

What if you aren’t accredited?

There are still opportunities.

If you use a broker but don’t have $1 million in net assets or an annual income of $200,000, your portfolio manager can file regulatory exemptions on your behalf that would allow them to allocate part of your investments to alternatives, Meyrick said.

Non-accredited investors can also seek investment products offered on wealth management platforms, which are “growing like crazy,” said Mike Woollatt, head of Canada for Hamilton Lane.

“There’s a whole bunch of small-to-medium and large … wealth platforms that have these buckets they put their investors in and then those buckets, in turn, invest in private markets,” he said.

Wealth platforms are increasing account thresholds, meaning users with $100,000 or $200,000 in their registered retirement savings plan (RRSP), for example, can access those products, too, without being qualified, he added.

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Wealthsimple Technologies Inc. launched a private-credit fund in March that’s managed by Sagard Holdings Manager (Canada) Inc. Clients who have at least $100,000 in deposits on the platform must make a minimum contribution of $10,000 to invest in the fund. It’s targeting a yield of nine per cent and because of risk, the company only permits users to allocate 20 per cent of their portfolio to the fund.

Before investing, beware

It’s important to keep in mind that private markets are considered opaque because they aren’t regulated the same as public markets and fees aren’t always transparently communicated.

Woollatt recommends relying on an investment adviser since they are qualified to “look under the hood” and understand if your needs and goals fit with the investment. He also echoed Meyrick’s advice that investors need to be in it for the long run.

“Regardless of the proliferation of types of investments, you should still think of (it) as a long-term investment because the underlying investments are relatively illiquid,” he said.

• Email: bbharti@postmedia.com

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