Wealth managers are promising their clients juicy returns with opaque private investments. They don't always have the niche expertise the $6.5 trillion market requires.
The new wealth buzzwords are private market investments: the industry's infatuation with finance that is inaccessible to most people was accentuated by the coronavirus crisis – not least thanks to their lack of correlation to traditional financial markets.
Private investors target promising companies that need financing for their break-through: the investments range from private equity, real estate, debt securities, infrastructure and natural resources to specialized funds, notes EPFL and Swiss Finance Institute, or SFI, professor Ruediger Fahlenbrach.
«More exotic assets like royalties, art, cars, and wine can also be included in the definition» he noted. Fahlenbrach co-authored an SFI research report on the topic, released last month.
Opaque Pricing
Whether wine or real estate, what all private investments have in common is that their value isn't determined by a publicly-traded marketplace, but what wealthy and institutional investors are prepared to pay for it. The arena is dominated by giants like Blackrock and Zug-based Partners Group.
McKinsey research shows that 2018 and 2019 were record years for private equity fundraising – especially in North America and Europe. Wealth managers are moving aggressively into the estimated $6.5 trillion market: Julius Baer recently poached UBS veteran Giuseppe De Filippo, as finews.com reported.
Continuous Monitoring
Renewed interest in the sector may sour: private investments are anything but ready-made financial products. They require enormous effort and continuous monitoring and engagement – traits that aren't necessarily the core skills of banks.
«It takes know-how to invest in the right firms because the supply is huge and it is difficult to separate the wheat from the chaff,» founder and co-CEO of Bulb Capital Michael Bornhaeusser told finews.com. Bulb is a Swiss-based investment house focused on technology investments in companies with digital business models.
Making Influence Felt
Do banks possess this expertise? Perhaps, but they must also actively engage as investors with their portfolio companies – for example, in a board role in order to shape strategy. Bornhaeusser emphasizes how closely investors need to chaperone their companies by making their influence felt in key strategy bodies.
«The company needs a plan so that the investors know they will get their money back, plus return,» Bornhaeusser notes. Zurich-based Syz Capital founder and CEO Marc Syz echoes this view, noting that traditional asset classes are either too richly valued to be interesting for private investors, or simply don't fit with the investment ideas of a new generation of clients.
Illiquid Market
Syz also questions whether banks possess the expertise to successfully navigate the nitty-gritty of private investments. «It takes small, agile firms,» he told finews.com. Funds are usually locked in for five to ten years – and unlike traditional market investments, are highly illiquid. There is no fast money: investors don't get their money back until the portfolio company is sustainably profitable.
The other major drawback for banks is that they can hardly scale private market investments in order to squeeze out more revenue – literally every investment is different. Swiss real estate investor Acron sets up a company for each of its investments: «It helps us not only to minimize the risk of individual investments but provides the most transparency that is possible in terms of due diligence, forecasting, and reporting,» CEO Peer Bender told finews.com.
Rude Awakening?
In order to marshal their resources, investors in highly specialized companies organize so-called club deals, hand-picked transactions in start-ups for a small circle of wealthy clients (start-ups, infrastructure, or real estate have proven especially popular). This makes the banks beholden to the outcome of the investment – the famous skin in the game.
Many banks don't have the structure of say-so to match these types of investments. Despite the potentially lucrative long-term payoffs of these deals, it is questionable whether banks – with their quarter-to-quarter obligations to their own investors – are equipped for them.
«Dry Powder» Danger
Private market experts voice fears of a new herd mentality in the sector, with the potential for a rude awakening, as in past episodes with hedge funds or structured products.
«My primary worry is that investors have committed a lot of 'dry powder' in the last few years and that their discipline with investments will relax as a result of the coronavirus crisis,» Fahlenbrach, the EPFL and SFI professor cautions.
