According to a recent survey by Apt Wealth Partners, only 42 per cent of the 889 high-net-worth (HNW) investors believed they understood how private equity works, while around a third (35 per cent) said they would ‘strongly agree’ they understood concepts such as liquidity and exit strategies.
Speaking with Money Management, Andrew Dunbar, director and senior financial planner for Apt Wealth Partners, described how his firm uses a tiered investment approach to mitigate this.
One way Apt Wealth addresses this challenge is through tiered investment availability. Through this, increasingly complex investments are made available to clients based on their level of financial literacy which is determined by a multilevel assessment process.
“We have a cascading approved list of investments, where you’ve got your general investments that are approved for retail clients, they’re transparent, easy to understand, and then you might have some more complex investments, like private markets and so forth, but that would be for the next tier up of investors who have that level of understanding.”
With this system, Dunbar said clients start out on a base level which considers their client objectives and values before moving onto factors such as investment preferences, risk tolerance, liquidity needs, and investment history.
“If they value peace of mind and security and don’t need extra risk to achieve their objectives, then there’s no need for the next tier. But if they want to maximise the chance of wealth growth and are risk-takers, that may mean they continue to assess for the next tier.”
Although a client’s understanding is the primary consideration in this system, Dunbar said they also factor in clients’ level of wealth as those clients with greater assets may have greater capacity to absorb some of the risks that come with private market assets and will be better able to diversify their portfolio.
“Advisers will spend time understanding clients’ history of investing – what have they invested in, what did they like/dislike, have they been through the GFC for example. They will spend time talking about risk and return, liquidity, income, exit strategies. Often this is something over time where clients display more knowledge as their education continues and they may cascade up overtime.”
Notably, he said a client’s own demand for a particular product such as alternatives is a factor they would only consider towards the end of the process once they have met the earlier criteria and only then would the adviser start discussing their benefits and risks.
Although they may have seen the products in the media, even HNW investors may demonstrate an overconfidence bias where they believe they have more understanding of what complex products can be than they actually do.
Even after this thorough process, Dunbar said clients will need to be approved by the investment team and head of advice, taking into account all gathered information, prior to them being moved up the cascade.
He also argued the importance of establishing an exit strategy before investing in these complex asset classes is crucial. Although lock-up periods may be fine for some investors, he said that this is an important consideration when it comes to ensuring a portfolio is properly diversified.
This is particularly important when it comes to private markets, as times of market stress could see them unable to access their funds.
“If ready access is required, then it won’t be appropriate,” Dunbar remarked.
Touching back on the investment illiteracy of the asset class, illiquid private market investments affect both a clients’ financial and emotional health if they encounter a lock-up period which prevents them from withdrawing their investment.
Redemption periods can differ greatly between funds and private market ones may be limited to quarterly redemptions which can significantly impact how much a client can withdraw, especially if the manager needs to “fire sale” assets to meet redemptions.
For this reason, clients need to understand whether they are happy to periodically receive redemptions in this way, or whether they want to be able to withdraw their money all at once.
Dunbar said: “It’s often easy to get into things and then hard to get out. So before we go into anything, I think just asking yourself, what’s your exit strategy? How simple is the exit?
“If we do get some more volatile periods or these funds enact their lock-ups, you create a misalignment of expectations for clients, which is a problem. If we go through a period of volatile markets and maybe these funds don’t perform to expectations, they lock up capital. Liquidity is not there, that’s going to have a big impact, not just on them financially, but on their confidence, peace of mind, and lifestyle as well.”
