Why Private Markets Are a Diversification Superpower

A pie chart in multiple colors represents a diversification strategy.

(Image credit: Getty Images)

published 8 August 2024

As wealth advisers, we talk to our clients about the power of diversification at every meeting. Some parts of a portfolio may be going up when others are going down. More recently, high-quality diversification is hard to find. Why? Public markets continue to shrink. Market concentration continues to rise, and the Magnificent 7 stocks drive most of the returns in the S&P 500 index.

The current scenario means many investors face heightened risks that come with a less diversified investment mix and higher correlation of standard asset classes. Meanwhile, private markets are increasingly eclipsing their public counterparts — more than 85% of U.S. companies with revenue exceeding $100 million are privately held, according to Bain estimates.

These dynamics, while not entirely new, present a compelling case for an adequately diversified portfolio — comprising both public and private investments — to help lower portfolio volatility and potentially achieve better returns. This is the case for qualified purchasers — natural persons with $5 million or more in investable assets. That’s an SEC requirement. These are high-net-worth/ultra-high-net-worth families who have the capacity to invest for the long term and who are willing and able to exchange liquidity for higher potential returns.

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Overcoming historical barriers to private markets

Historically, accessing private markets has posed significant challenges, even for the wealthiest investors. Steep costs and high minimum investment thresholds have kept the benefits of private markets — such as private equity (PE), real estate, venture capital (VC), private credit and infrastructure — out of reach for many. However, recent developments are changing this narrative, making private markets more accessible, with lower minimums, to a broader range of investors.

In addition, technological advancements have streamlined the complexities of accessing and managing these investments. Many modern private market platforms offer a digital experience for financial advisers, enabling them to model client asset allocations, standardize performance reporting and tap into educational resources. Furthermore, investors can now electronically sign subscription documents, expediting what was once a cumbersome process.

Potential benefits of private market investments

There are two major reasons why qualified purchasers should consider private markets. First, incorporating growth and income-focused allocations from private markets can help enhance an investor's existing portfolio outcome by potentially boosting returns and yield relative to public markets. Potentially higher returns are also derived from an illiquidity premium, where investors have the potential of incremental returns for holding, typically for several years, less liquid assets. Second, diversifying across various asset classes, industries, vintages and strategies can reduce risk by introducing less-correlated sources of return. This diversification is designed to help safeguard against market volatility and economic downturns.

Considerations before investing in private markets

While investing in private investments has many benefits, these investments come with their own unique set of challenges and considerations. Fees and expenses are typically higher than traditional investments, and private markets funds are long term and illiquid, with funds often being unavailable for up to 10 years.

Before investing, it is important to determine how much money you are willing and able to commit to these investments for the long term.

Additionally, some private investments are subject to regulatory restrictions on access and may have specific legal and tax requirements that need to be discussed prior to investing.

A strategic advantage for modern portfolios

In light of a shifting financial environment and the growing concentration in public markets, a diversified approach that includes private market investments is fast becoming essential for many qualified investors. Private markets offer the potential for enhanced returns, increased yield and broader diversification. Furthermore, advancements in technology place these investments within reach for a wider range of individuals and families. As such, qualified purchasers should talk to their financial adviser about whether private market investments are suitable for their situation.

The integration of private market investments as part of a well-rounded portfolio can offer a strategic advantage in today’s market environment. With the right approach and tools, investors can unlock the potential of these investments, to help them achieve their financial goals and position themselves for long-term success.

All expressions of opinion reflect the judgment of the author as of the date of recording and are subject to change. Some of the content provided comes from third parties that are not affiliated with Mercer Advisors. The information is believed to be accurate but is not guaranteed or warranted by Mercer Advisors.

This information is provided for informational purposes only and is not intended as and may not be relied on in any manner as legal, tax or investment advice, a recommendation, or as an offer to sell, a solicitation of an offer to purchase or a recommendation of any interest in any fund or security Any such offer can be made only via the relevant access fund's formal offering documents. This information is not intended to address the financial objectives, situation or specific needs of any individual investor. All investing involves risk including the possible loss of principal. Diversification does not ensure a profit or guarantee against loss. Investing in private funds is speculative and will entail substantial risks. Mercer Global Advisors Inc. is registered with the Securities and Exchange Commission and delivers all investment-related services. Mercer Advisors Inc. is a parent company of Mercer Global Advisors Inc. and is not involved with investment services.

Disclaimer

This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.

Kara Duckworth is the Managing Director of Client Experience at Mercer Advisors and also leads the company’s InvestHERs program, focused on providing financial planning to serve the specific needs of women. She is a CERTIFIED FINANCIAL PLANNER and Certified Divorce Financial Analyst®. She is a frequent public speaker on financial planning topics and has been quoted in numerous industry publications.