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The Role of Private-Market Investments in Today’s Portfolios

Tony Davidow unpacks risks and opportunities of alternative investment strategies.


Key Takeaways

  • A clear definition for alternatives.

  • How to use alternatives to help reach investing goals.

  • The risks and opportunities of alternative strategies.

Alternative investment strategies have become more accessible than ever before with product innovations like interval funds and tender-offer funds. But to take advantage of the opportunity, investors need to take a thoughtful approach.

Tony Davidow believes those factors are converging at the right time for a more robust, durable alternatives playbook.

Tony is a senior alternative investment strategist for the Franklin Templeton Institute. He joins the podcast to offer his take on expanding alternative investment opportunities.

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What are alternative investments?

The exact definition of alternative investments can vary, which can cause problems for investors down the line. Sometimes, the term becomes a catch-all for anything that doesn’t fit the classic definition of stocks, bonds, or cash.

“The more that we put everything in one bucket and assume the same sort of outcome, we create a lot of confusion for advisors, and ultimately for investors,” Tony says.

Tony defines alternative investments as the private markets: private equity, private credit, private real estate, and hedge fund strategies.

Are private market investments a fad or here to stay?

After the 2008 global financial crisis, a lot of advisors sought out options to insulate client portfolios from market shocks. Firms took hedge fund strategies and offered them in a mutual fund wrapper. These liquid alternative funds try to rearrange types of investment risks to deliver returns that don’t correlate with traditional asset classes.

But advisors saw mixed results.

While these funds sought to replicate hedge fund strategies, regulatory oversight meant they often lacked the same level of flexibility or access to investment opportunities. The complexity of these strategies made them hard to understand for the investors who owned them.

“A lot of advisors were disappointed because liquid alternatives didn’t fulfill the promise,” Tony explains. “And part of the reason was we didn’t have the right wrapper.”

Now alternatives are back in vogue. Will things be different?

Tony points out that today, demand resides in the private markets, which are illiquid by nature. Today’s offerings are now available at lower minimums and at any point in time, instead of waiting for a subscription period. While these vehicles come with provisions, they in many ways retain the benefits of illiquid investments.

This includes options like:

  • Interval funds, which allow shareholders to participate in periodic repurchase offers where investors can withdraw money from the fund.
  • Tender offer funds, which pool money from multiple investors to create a diversified portfolio of stocks. The fund manager uses this pool to participate in tender offers, or public request for shareholders to sell a certain number of their shares at a specific price.

How can investors use private market investments to build better portfolios?

Many advisors and investors believe they should be 100% liquid. But Tony says there’s a behavioral benefit to less-liquid investments.

“Investors all say that they're long-term oriented until we hit a bump in the road,” he explains. “Investing in private markets and instilling long-term discipline is good for investor behavior.”

Tony recommends considering alternative investments holistically, as part of a total portfolio approach. He hopes to shift the conversation away from performance of individual holdings and toward a role in the overall portfolio—such as growth, income, defense, or inflation hedging.

“If there are shocks along the way, clients could make more tactical moves in the liquid portion of their portfolio,” Tony says. “But at least for a portion of their money, they would have that long-term discipline.”

Tony encourages advisors to develop an illiquidity bucket for their clients. He says that at the beginning of a client relationship, advisors should determine how much clients would be comfortable holding for seven to 10 years in order to take advantage of the illiquidity premium.

“I always want to establish that more realistic timeframe to measure the results,” he says. “I expect to see an illiquidity premium excess return, relative to the public market equivalent for private credit and private real estate. But it has to have the patience to think of that as a long-term investment.”

Our job isn’t to avoid the bumps in the road, but to help prepare for them. We’re not in the risk avoidance business as much as we’re in the risk management business.

What’s Next for Alternatives?

As the industry grows, Tony hopes to see the broad-based allocation to private markets grow incrementally over time. To get these, advisors need to simplify how they talk about alternatives.

“The jargon can be a little confusing,” he admits. “We need to focus on the value and the role that these investments play in portfolios and measure the success over time. “

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This material reflects the analysis and opinions of the speakers as of February 22, 2024, and may differ from the opinions of portfolio managers, investment teams or platforms at Franklin Templeton. It is intended to be of general interest only and should not be construed as individual investment advice or a recommendation or solicitation to buy, sell or hold any security or to adopt any investment strategy. It does not constitute legal or tax advice.

The views expressed are those of the speakers and the comments, opinions and analyses are rendered as of the date of this podcast and may change without notice. The information provided in this material is not intended as a complete analysis of every material fact regarding any country, region, market, industry, security or strategy. Statements of fact are from sources considered reliable, but no representation or warranty is made as to their completeness or accuracy.

What Are the Risks?

All investments involve risks, including possible loss of principal. The value of investments can go down as well as up, and investors may not get back the full amount invested. 

Investments in many alternative investment strategies are complex and speculative, entail significant risk and should not be considered a complete investment program. Depending on the product invested in, an investment in alternative strategies may provide for only limited liquidity and is suitable only for persons who can afford to lose the entire amount of their investment. An investment strategy focused primarily on privately held companies presents certain challenges and involves incremental risks as opposed to investments in public companies, such as dealing with the lack of available information about these companies as well as their general lack of liquidity. Diversification does not guarantee a profit or protect against a loss.

Risks of investing in real estate investments include but are not limited to fluctuations in lease occupancy rates and operating expenses, variations in rental schedules, which in turn may be adversely affected by local, state, national or international economic conditions. Such conditions may be impacted by the supply and demand for real estate properties, zoning laws, rent control laws, real property taxes, the availability and costs of financing, and environmental laws. Furthermore, investments in real estate are also impacted by market disruptions caused by regional concerns, political upheaval, sovereign debt crises, and uninsured losses (generally from catastrophic events such as earthquakes, floods and wars). Investments in real estate related securities, such as asset-backed or mortgage-backed securities are subject to prepayment and extension risks.

An investment in private securities (such as private equity or private credit) or vehicles which invest in them, should be viewed as illiquid and may require a long-term commitment with no certainty of return. The value of and return on such investments will vary due to, among other things, changes in market rates of interest, general economic conditions, economic conditions in particular industries, the condition of financial markets and the financial condition of the issuers of the investments. There also can be no assurance that companies will list their securities on a securities exchange, as such, the lack of an established, liquid secondary market for some investments may have an adverse effect on the market value of those investments and on an investor's ability to dispose of them at a favorable time or price. Past performance does not guarantee future results.

Data from third party sources may have been used in the preparation of this material and Franklin Templeton (“FT”) has not independently verified, validated or audited such data. FT accepts no liability whatsoever for any loss arising from use of this information and reliance upon the comments, opinions and analyses in the material is at the sole discretion of the user.