CAN PRIVATE EQUITY DIFFERENTIATE AN ADVISORY PRACTICE?
Advisory professionals face a wide range of challenges in the course of building and running their practices. Some of the most pressing, especially for advisors whose income is directly proportionate to their assets under management, are related to achieving consistent growth in the size and number of client relationships. This includes finding ways to make themselves and their practices stand out among other similar providers, especially to wealthy and ultra-wealthy individuals and families. Advisor Challenges According to a report from iCapital Network, most advisors are focused on achieving growth and navigating the competitive environment. In particular, the nearly 450 registered investment advisors that took part in the firm’s research study cited the following four challenges (Figure 1).
These issues take on increasing complexity for advisors amid market uncertainty, a shifting regulatory landscape and the growing role of robo-advisors in the face of an aging practitioner base. While there are numerous ways to address these challenges, incorporating private equity into a practice may offer a possible solution to all of them.
In-Demand Products As seen in the research, having a continuously updated roster of products that reflect the latest techniques and opportunities is a priority for more than half of advisors. With just one in five surveyed professionals currently offering private equity (Figure 2), it is not yet considered a mainstream investment and could be seen as exclusive or differentiating for the advisors who include it in their suites.
At the same time, a recent report from Cerulli Associates indicates that alternatives (a catchall category that includes private equity and other private investments as well as hedge funds, commodities and real estate) still reflect just 3% of the overall asset allocation for advisory practitioners across the RIA, wirehouse, broker-dealer, bank and insurance verticals. This is significantly lower than the allocation to alternatives among institutional investors and family offices, Cerulli reports. Advisors that target wealthy investors may want to consider evolving their platform of offerings to more closely reflect those used by the largest and most sophisticated investors.
Wealthy Investors High-net-worth investors are longtime advocates of private equity in all its forms according to information shared by Tiger 21, a peer-to-peer networking group for wealthy individuals and business leaders. An August 2016 release from the group reports a 23% allocation to private equity across closely held stock, direct deals and funds, the highest since 2007. Similarly, iCapital’s research on single-family offices with average assets of more than $900 million indicates that 62% invest in private equity funds and direct assets, and the vast majority maintain portfolio allocations to private equity between 10% and 20%.
Advisors that want to attract new high-net-worth business will need to demonstrate an understanding of their investing priorities and have comparable offerings in order to win business.
Asset Growth The appetite among wealthy individuals and families for holistic wealth management support has prompted many advisors to shift their business models accordingly. As they have done so, AUM has become a standard metric for success that is directly related to revenue and personal income. Private investments generally and private equity funds in particular can attract much larger investments because they have much higher minimums. Most funds have $5 million entry points, and some are as high as $20 million. Even feeder access vehicles typically require investments in the $100,000 to $250,000 range, which may allow for more assets to be invested in private equity than in other types of investments and vehicles. At the same time, most private equity investments are illiquid and untradeable for a specified period of time, typically ranging from five to 12 years depending on the underlying assets or strategies. This allows the assets to remain undisrupted with an advisor for the life of the investment. The potential for private equity to attract larger, stickier investments is further bolstered by the long-term outperformance that the asset class has historically demonstrated relative to public equities and fixed income, which has helped to compound the effect on asset growth. Cambridge Associates Q3 2016 benchmark statistics show that U.S. private equity has delivered returns at least 300 basis points higher than the Dow Jones Industrial Average, the Russell 2000 and the Bloomberg Barclays Government/Credit Bond Index over 10-, 15-, 20- and 25-year periods.
Finally, there are numerous hurdles to growth for advisors, chief among them competition and a difficult market environment. The former can be addressed, the latter must be tolerated. But adding private equity into the product and service mix at an advisory practice may help distinguish a firm and its professionals in key ways among the coveted high-net-worth market.