Are alternatives still necessary for portfolio protection in 2025? Can financial advisors finally get over the tragedy of 2022 and move on from private investments already?
For those that may have banished the facts and figures from memory, stocks, as measured by the S&P 500, lost over 18 percent in 2022, placing that 12-month span in the bottom decile of stock returns over the previous century. Meanwhile, bonds, as measured by the Vanguard Total Bond Index, lost 13.3 percent in 2022, making it the worst year ever for US fixed income investors.
The big beneficiaries of all that public market carnage turned out to be alternative assets and their providers. That was because frantic financial advisors at the time took their money and sprinted to the relative safety of less liquid, private market investments.
Private equity exploded in 2022, posting its second-best year ever in terms of asset growth, according to Bain & Company. Wealth managers waved goodbye to 60/40 stock/bond portfolios during the selloff and said hello to 60/20/20 schemes, with that last piece being private equity. Or 50/40/10. Or any combination that inserted private equity in the mix to stop the red ink bleeding onto client statements and screens.
And then suddenly, without Wall Street’s warning, the bears went back to hibernating in their caves and the bulls reemerged. This time, however, with a vengeance.
The S&P 500 shot up 26 percent in 2023 and is on track to return close to 30 percent in 2024. Furthermore, the bullish sentiment on Wall Street remains strong heading into the new year. According to FactSet Research, the average analyst estimate points to the S&P 500 finishing 2025 at 6,679, up about 10 percent from its current level.
Meanwhile, bond yields are still fairly attractive despite the Federal Reserve’s best efforts with the 10-Year Treasury yielding around 4.4 percent. And the incoming president is promising lower taxes and deregulate to goose growth to boot.
Put all those public market tailwinds together and it kind of makes you wonder whether financial advisors still need all those private investments they stocked up on back when the world was falling apart in 2022.
“I don't favor increased alternative allocations,” said Josh Strange, founder and president of Good Life NOVA. “Today, I'm much more focused on aligning clients with quality equities and taking a flexible approach to bonds, favoring investment-grade bonds in the middle of the curve.”
In fact, Strange says when he talks about alternatives to clients of late, it's usually through the lens of tax mitigation strategies versus trying to boost their portfolio returns.
“That may not be exciting, but long-term, planning-focused investors sometimes need a boring strategy,” Strange said.
Elsewhere, Joseph Spada, private wealth advisor at Summit Financial, said he is holding onto his private market allocations because he believes that long-term performance and risk management will be enhanced by diversifying with private real estate, equity and credit.
“We believe that minority stakes in private investment companies and professional sports franchises will also add value to our client’s portfolios over the long term,” Spada said.
Steve Brennan, head of private wealth solutions at Hamilton Lane, said private market allocations have remained steady to slightly down over the last two years due to the step up in public market valuations. That said, he expects this trend will reverse in coming months with private market valuations significantly rising.
“Now that we have things like interest rates coming down, which should spur some additional investment activity in private markets, which will create exits for private market companies out into the market, really improve returns and give investors some capital back to take in, redeploy into the private market space,” Brennan said.
Because of the nature of private investments, in which an investment manager can add value not just by buying and selling assets but by actually improving the assets, the most attractive opportunities are often found during times of economic stress, when managers can purchase stressed or distressed assets, improve those assets, benefit from the passage of time and lessening of volatility, and sell the improved assets for higher multiples.
Brian Storey, head of multi-asset strategies at Brinker Capital Investments, does not foresee significant dislocation in 2025 across the entire economy, but instead in specific pockets like the commercial real estate industry.
“We know that many of the assets are impaired and may not possess attractive long-term fundamentals,” Storey said. “However, successful active managers will have the opportunity to find the diamonds in the rough and so we are excited about the potential for value add and opportunistic real estate. Likewise, we think that the energy industry is one to consider for opportunities in 2025 as the likely political agenda becomes more energy-friendly with less regulatory burden.”
Moving on, Brent Coggins, chief investment officer at Triad Wealth Partners, said the outlook for most private risk assets should be favorable in 2025 from a macro perspective.
“Higher expected growth, inflation that's higher than we'd like but not overly restrictive on the economy, plus positive real yield should all support various private assets in one way or another. Looking at them relative to the public markets, we'd look to marginally increase exposure to private assets starting next year, but more so from a long-term, strategic diversification standpoint as opposed to making a purely tactical decision,” Coggins said.
“Don’t rule out private credit having another good year as well, with the level of dry powder in private equity and more business turning to alternative sources of financing like private credit. Outstanding paper and new issuances should be supported and healthy, respectively.”
Erick Rawlings, head of manager research at Fiduciary Trust International, said higher interest rates and a tepid IPO market are creating opportunities in secondaries, or shares in established private equity funds, as large investors grapple with overallocations to private equity due to the slow pace of realizations.
“With large private equity investors slowing their new commitments, we also see the opportunity to commit to harder to access managers as they work to reach their fundraising goals. While discounts are available in some private market segments, other areas, such as AI and data-focused companies, have loftier valuations,” Rawlings said.
He adds that the ability to access top private equity managers is “imperative” in this environment because discriminating managers tend to be "better stewards of capital."
Finally, Patrick McGowan, managing director at Sanctuary Wealth Group, said he holds a “cautious optimism” towards private market investments heading into the new year.
“The strategy for 2025 involves increasing allocations towards stable sectors like real estate credit and infrastructure, holding firm in technology and software private markets to leverage sector growth, while being careful with exposure to direct real estate equity due to high capital costs and interest rate sensitivity,” McGowan said.
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