Questioning the value of velvet-rope investments

Firms that sell strategies based on access to exclusive relationships may be missing the mark

Questioning the value of velvet-rope investments

The idea of gaining access to exclusive products and services holds wide appeal in many industries and fields. With the right promotion and a primed consumer mindset, companies can convince people to pay handsomely for something behind a velvet rope, whether it’s a painting, or a door to a swanky night club — or an investment strategy.

“Not only does exclusivity sell extraordinarily well, but it also boosts an investment firm’s profit margins as investors are willing to pay substantially higher fees if they believe they are getting access to superior performance in return that few others can get,” wrote Martin Pelletier of TriVest Wealth Counsel for the Financial Post.

Pelletier noted how a firm’s exclusivity-based pitch typically goes: by leveraging strategic relationships, the firm is able to grant their clients exclusive access to a high-return, lower-risk investment opportunity has been largely available only to large institutions.

“However, when the exclusiveness factor dissipates, the focus once again returns to performance, and just how much investors are paying for it,” he said.

Citing a Bloomberg analysis, he said that passively managed US stock ETFs have seen their market share rise to 48.1% and are on their way to crossing 50%. To stem the shift into ETFs, active mutual funds have been forced to respond with dramatic fee cuts.

“The hedge fund world, too, has lost its appeal simply because short-term performance too often failed to translate over longer periods,” Pelletier continued. Based on an analysis by Axios, the average return of the S&P 500 has been nearly double that achieved by the average hedge fund since 2009. Investors have pulled an average of $5.4 billion per year from hedge funds since 2015; citing numbers from research firm eVestment, Axios said the number of hedge funds launched last year was the lowest since 2015.

But today, there appears to be a shift in interest toward the private asset market. McKinsey’s Global Private Markets Review 2018 showed a record $750 billion raised by private asset managers globally in 2017; it was also the second straight double-digit growth year in private equity after its 19% gain from 2015 to 2016. Private equity represented the largest segment of private assets, followed by private real estate and then private debt.

Professionals in the wealth-management industry, Pelletier said, have taken notice of this. With phrases such as “moving beyond stocks and bonds” and “alternative investment solutions,” he said many such professionals are promoting products that they argue have become necessary in the face of low interest rates and apparently stretched valuations in public markets.

“However, having worked in capital markets and directly with large pension plans and family offices, I have seen first-hand how the best quality private investments rarely made it to private clients,” he said.  Despite that, he noted, there’s still a deluge of private opportunities being pitched to regular investors, including mortgage investment corporations, private pools of direct real estate assets, private debt, and operating businesses.

“While we definitely see the merit of having some exposure to private assets, especially for those with a large accumulation of wealth, we remain concerned that the average investor may be wading into areas where they lack sophistication and haven’t performed the necessary due diligence,” he said.


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