Why UHNWIs Prefer Private Investments

There’s this public perception that the wealthy are wealthy because they inherited their wealth, got a lucky break, or stumbled onto their wealth, but most are self-made. The ultra-wealthy (aka ultra-high-net-worth individuals or UHNWIs) got where they are because of their efforts. Still, they achieved financial freedom by doing the opposite of everyone else. They didn’t follow tradition or the crowds and were willing to ignore the masses. So while everyone zigged, UHNWIs zagged.

UHNWIs dared to question everything they had been taught about money, finances, and investing. They were willing to buck the trends because they saw that what was the norm and what was being pushed by Wall Street and institutions like schools and family was not working for the average American.

Tied to 401(k)s, IRAs, or investment advisors, average Americans see much of their portfolios throttled by fees and expenses charged by investment professionals who manage their money. But, the only ones getting rich are these purported professionals who get paid whether their clients make money or not.

It’s no surprise that most Americans are unprepared for retirement even though they’ve spent their entire careers contributing to these same investment vehicles everyone else is allocating to. The norm doesn’t work. UHNWIs know that, and that’s why they don’t invest like the average investor.

In the world of investing, you have two markets: one public and one private. In the public markets, traditional assets like stocks and bonds are available widely to most investors. Public assets like stocks trade on the open markets, available to any adult, meeting minimum requirements like being an adult and having a bank account.

Stocks traded on public exchanges are registered securities, which means the underlying companies went through a rigorous process with the SEC to go public and to offer their stock through an initial public offering (IPO). Public companies must provide the investing public with ongoing detailed financial data and company information for the public to make informed decisions. This information is expected to be updated on a quarterly and annual basis in order for investors to have the most up-to-date information.

When was the last time you read through a public company’s prospectus or reviewed its latest audited financial statements before buying a stock?

If you’re like most investors, the answer is likely not recently and probably never. The average investor doesn’t pick a stock based on an analysis of economic data or underlying fundamentals.

They pick stocks based on emotions – emotions swayed by what the talking heads are saying on cable news and the internet and what social media is chattering about. It’s why stocks of bankrupt or near-bankrupt companies skyrocketed during the pandemic. They were driven by the madness of the crowds and public mania.

UHNWIs are turned off by all the variables that go into public stock prices. They don’t like handing their financial fates over to herd behavior and the madness of the crowds driven by irrationality and emotions. That’s why they prefer the private markets insulated from the crowds.

What is a private investment?

As the name implies, private investments (i.e., private placements, investments in private companies, or private equity) are not readily available to the public and are typically restricted to qualified investors who possess both the financial sophistication and the resources to withstand investment losses.

Because private companies are not subject to the same strict reporting requirements as their public counterparts, they must be selective in who they allow to invest to qualify for an SEC exemption from registration. The qualification requirements are meant to deter unsophisticated investors who don’t fully understand the risks of private investment and can not afford potential losses.

The most common requirement for investing in a private investment is that the potential investor qualifies as an Accredited Investor.

As the term applies to individuals, an Accredited Investor is a person that meets one of the following criteria:

  • Have a net worth exceeding $1 million individually or combined with a spouse (excluding the value of the primary residence).
  • Have earned income exceeding $200,000 ($300,000 if combined with a spouse) during the last two calendar years, with a reasonable expectation of maintaining these income thresholds during the current year.

 
The fact that private investments are not traded on the public markets and are typically reserved for Accredited Investors is what draws UHNWIs to passive private investments – particularly investments in private companies (i.e., private equity) and pooled real estate investments (i.e., syndications).

Investing in passive private investments allows sophisticated investors to co-invest with other sophisticated investors. And because private investments typically have long lock-up periods, this illiquidity prevents investors from liquidating their positions at the first sign of trouble. This insulation from the madness of the crowds and broader market volatility is what draws UHNWIs to private investments.

UHNWIs have long been drawn to private investments like private equity and syndications for decades.

See the following chart:

Tiger-21 is an investment club consisting of North American and European UHNWIs with a minimum of $50M in investable assets required to join. Members of Tiger-21, like many UHNWIs, typically allocate more than 50% of their portfolios to private equity and commercial real estate.

Besides being insulated from market volatility, there is a multitude of other advantages that draw them to this class of assets.

Here is a summary of these advantages:

  • Above-Market Returns.
  • Inflation hedge.
  • Passive Income.
  • Appreciation.
  • Low Volatility.
  • Tax Benefits.
  • Con-Investment Opportunities.

 

Higher Returns At Less Risk…

The more an investor allocates to private alternative assets, the better that portfolio will perform and at less risk.

 

– Source: JP Morgan Asset Management

Partnering With Experts…

UHNWIs have discovered that the key to building, growing, and sustaining wealth is not trying to do everything independently.

The key is to generate passive returns from cash-flowing private assets without the headaches. By letting someone else with expertise and knowledge do the work involved with a particular asset, UHNWIs can create multiple streams of passive income by partnering with multiple experts to compound wealth exponentially by reinvesting cash flow.

Recession And Inflation Insulated…

Besides generating higher risk-adjusted returns, private investments are insulated from Wall Street volatility and offer a hedge against inflation in the right segments.

UHNWIs have long hedged against inflation by allocating to assets that generate income and appreciation that keep pace with and even exceed inflation. Commercial real estate is one such example of an asset that hedges against inflation.

According to the chat above, real estate outperforms the market in an inflationary environment – making it ideal for generating income that keeps pace with or exceeds inflation.

It’s not hard to see why UHNWIs prefer private investments over public options, but fear of the unknown stops many investors from following their lead. UNHWIs were all faced with this same dilemma at one time or another, and all made the right decision to follow their instincts and go against the crowds. It just takes a leap of faith.