By Grace Williams, in Financial Advisor IQ, featuring Taylor H. Sutherland, CFP®, CIMA® AIF®, Director of Portfolio Strategy/ Senior Wealth Advisor at Halbert Hargrove
This is the first article of Financial Advisor IQ’s five-part special report on private market investments.
Investor interest in private credit has intensified in recent years, as asset managers look to bring this asset class to the retail market. Morgan Stanley estimates private credit assets could reach $5 trillion by 2029, after reaching $3 trillion last year from just $2 trillion in 2020. For asset managers, however, tapping into individual wealth has required a slate of products geared toward their needs. The result: hybrid products that combine private and public market access with lower investment minimums and increased liquidity when compared to institutional offerings.
“Historically, you needed significant wealth to join these markets or to meet qualifying standards,” said Taylor Sutherland, director of portfolio strategy and senior wealth advisor at Halbert Hargrove. Hybrid funds help democratize the private markets by making them more accessible.
Key Takeaways
- Hybrid investment products are making private market investing more accessible. Vehicles such as interval funds, evergreen funds, and ETFs allow more investors to gain exposure to private credit, private equity, and other alternative investments.
- Liquidity remains an important consideration. While hybrid products offer greater flexibility than traditional private investments, investors should understand the differences between liquid, semi-liquid, and illiquid investment structures.
- Private market investing can enhance portfolio diversification. Advisors often use hybrid investment products to complement traditional stocks and bonds rather than simply pursue higher returns.
- Not all hybrid funds operate the same way. Understanding how interval funds, evergreen funds, and other structures manage subscriptions and redemptions is essential before investing.
- Successful implementation starts with thoughtful financial planning. Hybrid investment products should be evaluated within the context of an investor’s goals, risk tolerance, liquidity needs, and long-term portfolio strategy.
Where to Begin
Hybrid products typically blend alternative investments, such as private credit, private equity, infrastructure or even real estate with traditional equity or fixed income. By doing so, they are able to introduce limited liquidity into the fund, whereas a purely alternative fund would typically have much longer lockups. However, they remain less liquid than traditional funds, depending upon the structure of the particular fund.
Not all hybrid structures operate in the same way, and the differences will affect both how client money is invested and how often they will have opportunities to take their money out of the funds.
For example:
Evergreen funds: These funds are open-ended, pool investment capital, have no termination date and accept new capital on an ongoing basis. Investors can subscribe or request to redeem shares on a periodic basis.
Interval funds: These funds pool money, lend to private companies and allow scheduled withdrawals. Investors gain access to less-liquid but high-yielding private market products such as private credit or private equity.
ETFs: Provide investors with a blend of investments and asset classes in a single, exchange-traded fund.
Advisors must clearly communicate the difference between liquid, semi-liquid and illiquid investments to their clients.
Understanding Semi-Liquidity
While hybrid and semi-liquid products offer upside by giving investors access to asset classes they might not otherwise have, they also come with caveats. One particular feature that must be addressed upfront is that of liquidity.
Advisors must clearly communicate the difference between liquid, semi-liquid and illiquid investments to their clients. For clients accustomed to accessing their investments on an as-needed basis, the less liquid nature of private market investments can remain a hiccup, even if they invest in a hybrid product. Sutherland says that adjustment can be difficult for retail investors who might be accustomed to pulling money from their accounts in times of market stress.
“You can’t turn illiquidity into liquidity,” said Michael McClain, alternative investment research analyst and due diligence at LPL Financial, which recently added interval and evergreen funds. Hybrids typically offer shorter lockup periods and more regular redemption windows than traditional alts, but advisors still must also highlight the restrictions these investments impose to investors who may be used to buying and selling at will.
“Three-quarters of our offerings have some liquidity feature, quarterly, semiannual, or ongoing via evergreen structures; that’s our preferred access point,” said McClain.
Fitting the Product to the Client
Given the illiquidity and various ways these funds operate, it is reasonable for an advisor to hesitate or wonder what the ideal introduction scenario might be.
One way to present these products is to highlight their strength. “We like to stress the diversification over the return component,” said McClain. Because returns are not guaranteed, diversification can help mitigate the risk. For instance, a mature private equity fund-of-funds could have about 2,000 positions underlying them on a look-through basis. “That’s incredible diversification,” said McClain.
When adding products to any portfolio, allocation is a key decision advisors need to make. Whereas traditional alts were only available to investors willing to invest $1 million for a single strategy, single manager option, Halbert Hargrove’s Sutherland explains that hybrids have helped bring these strategies to the masses. “These things have become more broadly available with liquidity terms that I think are reasonable,” Sutherland said.
Using the example of a client with $1 million to $5 million, Sutherland added, [now] “we can dedicate 5% of a portfolio to this investment where previously that wouldn’t have been an option.”
Although newcomers face a learning curve, a clear conversation about hybrid funds that outlines the unique nature of these investments can boost the client-advisor relationship and add resiliency to a portfolio.
This article was independently reported and written by a journalist with Financial Advisor IQ without any input from our exclusive advertising partner.
