Perhaps the biggest difference between how most people’s money is invested and how their

pension plans

invest boils down to how both groups see the role of private assets in portfolio construction. Most investors have no exposure to private assets at all. Those who do, usually have a modest stake, such as less than 10 per cent, in private investments. Pension plans, in contrast, often have about half their assets invested in private offerings. The difference is stark.

For generations, retail portfolios have been constructed using publicly traded securities exclusively. These are easy to buy and trade, easy to understand and efficiently priced, and widely available in retail-friendly formats such as

mutual funds

and

exchange-traded funds

. Part of the reason for the resistance to private assets is familiarity. People just like to invest in things they feel they know and understand. Another part of the reason is that the companies that employ advisers who work with retail investors need to do more due diligence and therefore take on more reputational risk if the products go sideways.

Despite this, there are at least three compelling reasons for retail investors to consider private assets.

First, there’s

diversification

. Private assets often have a lower correlation to other assets, including those that trade publicly, than other asset classes. By combining assets that “zig” when others “zag,” the overall risk is often reduced.

Second, there’s the potential for higher long-term returns. Also known as the illiquidity premium, this is the flip side of the above point. Using more private assets might not only lower risk, it could also increase return. While risk and return are related, the relationship isn’t one to one. Investors who can accept longer lock-ups and less frequent pricing in exchange for the possibility of higher returns often fare quite well if they are disciplined and patient. It merely underscores that many private opportunities involve longer horizons.

Finally, there’s the ability to access unique opportunities and strategies, including exposure to asset classes and strategies not typically available in public markets. The most obvious include

private equity

, private credit and niche real estate such as farmland, but there are also unique offerings on ideas such as renewable energy and music royalties available.

The story isn’t all sunshine and rainbows, however. There are some important caveats to keep in mind.

The most obvious concern is illiquidity and lock-up periods. Most private funds require multi-month commitments with a limited ability to make withdrawals. I find that concern a bit silly because the financial services industry constantly tells investors to take a long-term view. Telling people to take a long-term view while being concerned about having to wait 91 or 120 days to get your money out is simply inconsistent. The industry needs to pick a lane. Is it concerned about investors not getting out of GICs for a year before they mature? Are banks worried that their mortgage clients might not be able to sell their home in 120 days? Not really.

A second concern is higher minimums and fees. Entry thresholds and fee structures can be substantial. This “access constraint” can be overcome by working with a qualified portfolio manager. While buying private assets usually requires that the purchaser be an accredited investor (in other words, deemed by regulators to be sophisticated), that status and the resulting access to specialized funds is removed if the investor is working with a portfolio manager who has a fiduciary obligation to do proper due diligence and put client interests first.

In addition to the garden-variety illiquidity of waiting three months or more to get your money out, there’s the awkward possibility that from time to time, some products may be “gated.” In simple terms, that means the manager might not have the liquidity available to meet even a legitimate redemption, such as with three months’ notice. When that happens, all unitholders are precluded from selling until the money for the redemption can be raised. This is to protect existing unitholders from what might otherwise be a need to sell some of the fund’s assets at distress prices. Note that it does not usually mean there is anything wrong with the investments in the fund.

Last, there’s transparency and valuation risk. The valuations of private assets are less frequent (typically monthly) and less transparent than public markets, so monitoring can be less straightforward. They often involve the assessments of auditors rather than trading data based on the underlying assets. Critics of this lack of both liquidity and transparency call the monthly reporting “volatility laundering” because the investments are not marked to market daily like stocks, bonds, mutual funds and exchange-traded funds are.

Here are a few additional tips for those buying private assets for the first time. Be sure to assess suitability with a financial adviser to determine if private assets fit your goals, time horizon and risk tolerance. My view is that if considered honestly, virtually everyone can have at least some exposure, and many people could reasonably tolerate a substantial allocation. At a minimum, I encourage readers to consider a moderate allocation to private assets as part of a broader diversified portfolio.

If using an adviser, get that person to perform a thorough due diligence: review track records, fee structures, liquidity terms, fund strategy and risk disclosures.

Most critically, you should diversify thoughtfully: Spread risk across a few strategies and asset types to avoid concentration risk. Don’t put more than a modest amount into any one product or strategy.

It has been said that the enemy of the good is the perfect. While private assets have their warts, I nonetheless believe the positives outweigh the negatives by a substantial margin. Given the ridiculously high valuations of many publicly traded securities these days, disciplined investors who are approaching or in retirement shouldn’t be chasing higher returns. Instead, designing portfolios involves being able to withstand disappointment. Institutional investors have long understood this. Retail investors deserve greater access to products that offer the same mindset.

John De Goey is a portfolio manager with Designed Securities Ltd., regulated by the Canadian Investment Regulatory Organization and a member of the Canadian Investor Protection Fund.

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