Summary - Investment Podcast 17 – Alternatives (Private Markets)

The world of finance has changed dramatically over the last few decades, and so has the array of investment opportunities available to professional advisors and their clients. While the traditional blend of equities, bonds, and cash has long been considered sufficient for a “balanced” portfolio, recent market developments and a new macroeconomic environment have shifted the spotlight toward alternative investments. Within this broad category—often referred to simply as “alts”—private market investments have found a steady foothold, migrating from niche territory to mainstream acceptance among sophisticated and everyday investors alike.

This article, adapted from a podcast featuring James Whelan (Managing Director at Barclay Pierce Capital’s Wealth Management Team), Sinead Rafferty (Senior Investment Specialist at Fidante Partners), and Vesna Peroska (Portfolio Manager at Morningstar), offers a professional, ethically driven examination of how private market alternatives fit into client portfolios. Throughout, we emphasize the importance of transparency, due diligence, and ethical considerations—key principles that guide professional advisors in acting in the best interests of their clients.

1. Introduction: The Importance of Professionalism and Ethics

Professionalism in financial advice extends beyond mastering investment strategies; it is rooted in a dedication to duty of care, transparency, and client-centric decision-making. Ethics are at the very heart of these responsibilities. Whether advising retail investors, high-net-worth individuals, or large institutions, an advisor must ensure that investment recommendations align with the client’s best interests, risk appetite, and goals.

Private market alternatives have traditionally been accessible only to institutional players and ultra-high-net-worth individuals. Today, the “democratization” of these investments has made them more accessible. But that greater accessibility does not negate the need for thorough due diligence, awareness of liquidity constraints, and full disclosure of risk profiles. Advisors must also be diligent in assessing the potential for higher fees, the complexities of valuation, and the possibility of conflicts of interest.

This discussion focuses on two major branches of private markets—private credit and private equity. We explore the strategies, market conditions, and ethical considerations that advisors should bear in mind when recommending these investments to clients.

2. What Are Private Market Alternatives?

In broad terms, “alternative investments” refer to assets that do not fall into traditional categories such as equities, bonds, or cash. Examples of alternatives include hedge funds, commodities, infrastructure investments, private debt, real estate, and more. Within that vast array, “private market alternatives” describes investments not traded on public exchanges—private credit, private equity, venture capital, direct real estate, and privately held infrastructure projects all fall under this umbrella.

2.1 The Rationale Behind Private Market Investments

• Diversification: One of the strongest arguments for private market investments is the potential diversification benefit. Private markets often invest in sectors or business models not commonly found in publicly listed markets. This broader opportunity set can help smooth out portfolio volatility.
• Return Potential: Historically, private equity and private debt strategies have generated attractive risk-adjusted returns. They are often seen as an avenue for enhanced yields (in the case of private credit) or higher capital growth (in the case of private equity).
• Lower Mark-to-Market Volatility: While not inherently “safer,” many private market strategies do not experience the daily price swings characteristic of public markets. The resulting lower measured volatility can be appealing, though it can also obscure the true risk if investors do not perform adequate due diligence.

2.2 Ethical Considerations from the Outset

Any promise of higher returns or diversification must be balanced with transparency about fees, lock-up periods, and the fact that these vehicles may carry higher levels of complexity and potential risk. Advisors have a responsibility to ensure clients understand the time horizon required for such investments. Maintaining transparency and integrity about risks, manager selection, and historical performance data is paramount.

3. The Changing Macroeconomic Environment: Why Alternatives?

Over the past decade, advisors grew comfortable with the “60/40 portfolio”—60% in equities and 40% in bonds—as it generally delivered solid returns in a declining interest-rate environment. However, 2022 and beyond saw a swift rise in interest rates across global markets, which altered the correlation dynamics between stocks and bonds.

Where once bonds and equities were often negatively or minimally correlated, recent episodes have shown them moving in tandem more frequently. As Sinead Rafferty highlights, in 2022, the S&P 500 posted double-digit losses, while broad bond indices also suffered losses, dragging the traditional 60/40 portfolio into deeply negative territory. This breakdown in historic correlation patterns has underscored the need for additional uncorrelated or low-correlation investments in a portfolio—leading many advisors to re-examine the role of alternatives.

3.1 Higher Inflation and Normalizing Interest Rates

According to Vesna Peroska, the recent environment of elevated inflation and “normalized” interest rates is reminiscent of times past—though it might feel unfamiliar to those who have known only low inflation and near-zero interest rates. Higher inflation erodes real returns, and rising rates tighten monetary conditions, forcing advisors to seek other sources of alpha and uncorrelated returns.

3.2 Liquid vs. Illiquid Markets in a Shifting Environment

One hallmark of private markets is their illiquidity. While that might seem like a disadvantage, this characteristic can also act as a behavioral buffer, preventing investors from panic-selling in volatile markets. Ethically, however, advisors must clarify that “illiquid” does not always mean “safe,” and that the lack of mark-to-market pricing can mask inherent risks. Still, for investors with longer horizons and capacity for illiquidity, private markets may offer the dual benefit of diversification and disciplined long-term investment.

4. Private Credit: An Income-Focused Alternative

Private credit, sometimes referred to as “direct lending” or “private debt,” involves non-bank entities lending capital to companies. These loans may be senior-secured, asset-backed, or subordinated, and often carry floating rates tied to an index such as LIBOR (historically) or other benchmark rates.

4.1 Why Private Credit is So Popular

• Attractive Yields: With rates rising, private credit can deliver higher spreads over cash or benchmark rates. Some strategies may provide low double-digit returns for relatively moderate levels of risk.
• Floating Rate Structure: Many private credit deals have floating rates, enabling investors to keep pace with rising interest rates. In an inflationary environment, this feature can help maintain real yields.
• Short Duration: Private credit loans often have a duration of one to five years. By staggering multiple loans within a fund, managers can create an ongoing cycle of capital deployment and redemption, which assists in liquidity and risk management.

4.2 Ethical Due Diligence in Manager Selection

Because private credit deals often involve unrated issuers, the manager’s expertise in credit analysis and risk mitigation is critical. Advisors must scrutinize:

1. Team Quality and Track Record: Has the manager navigated different credit cycles? The more experience a team has through both expansions and recessions, the more likely they can anticipate default risks and restructure loans effectively.
2. Origination Platform and Relationships: Private credit hinges on deal flow. Reputable managers often have longstanding relationships with borrowers, enabling them to negotiate favorable terms and perform rigorous due diligence.
3. Underwriting Standards: Ethical underwriting demands objective third-party valuations, reliable collateral, and clear covenant structures. Advisors should question whether the fund obtains monthly or quarterly valuations from external parties, and whether they make those valuations accessible to stakeholders.
4. Default and Workout Strategies: Even the most conservative credit strategies can face defaults. Skilled managers know how to renegotiate terms, infuse extra capital, or pursue asset takeovers—when ethically and financially justified—to safeguard investors’ capital. Transparency around these workout scenarios is key.

4.3 The Risk of “Opaque” Private Credit

Critics of private credit often label it “opaque.” The truth is, many segments of private credit can indeed be less transparent than public bond markets. However, high-quality managers typically perform rigorous due diligence and retain third-party valuation agents to ensure loans are marked fairly. As an advisor, one must consistently advocate for and verify these external checks and balances.

5. Private Equity: Growth-Oriented Opportunities

Private equity typically involves taking an ownership stake in privately held companies. Strategies run the gamut from early-stage venture capital (VC), which invests in start-up companies, to leveraged buyouts (LBOs), which target mature companies for acquisition, often using debt to enhance returns.

5.1 The Spectrum of Private Equity

• Venture Capital: Invests in start-up or early-stage businesses with limited or no revenue. This end of the market usually carries high risk but also the potential for outsized returns.
• Growth Equity: Targets more established companies looking to scale. While still high-growth, these businesses often have proven revenue models and thus present somewhat lower risk than VC.
• Leveraged Buyouts: Involve purchasing controlling stakes in companies, often using a mix of equity and debt. Large buyouts aim to streamline operations, improve profitability, and eventually exit at a higher valuation.
• Carve-Outs and Special Situations: Focus on parts of companies that may be underperforming or non-core assets.

From an ethical standpoint, each of these strategies must be evaluated for its corporate governance and operational practices. The manager’s plan to enhance profitability might include changes to staffing and cost structures, so a discussion about the manager’s approach to organizational culture and ethical corporate governance is valid for conscientious clients.

5.2 Balancing Returns and Liquidity Constraints

One defining characteristic of private equity is the long-term lock-up period, which can last 7–10 years or more. Advisors must ensure that clients who invest in private equity strategies understand that this illiquidity is a feature, not a bug—investors gain the potential for higher returns while giving the manager time to restructure, grow, and eventually exit the business.

However, as Sinead Rafferty points out, timing matters. The so-called “vintage risk” in private equity refers to the macro environment under which a manager deploys the capital. If the investment window happens to coincide with rising rates, high valuations, or economic headwinds, subsequent returns may suffer. A practical and ethical solution is to diversify across multiple funds or “vintages” over several years, mitigating the impact of poor timing in any single cycle.

5.3 The Ethics of Disclosure in Private Equity

Due diligence in private equity is multi-layered, potentially involving:

1. Operational Due Diligence: What improvements does the manager plan to implement? How will they treat existing employees, and will there be substantial layoffs to meet profit targets?
2. Financial Transparency: Are outside auditors conducting regular valuations? Does the general partner (GP) openly disclose fees, including performance fees, management fees, and any transaction-related fees?
3. Corporate Governance: Does the private equity firm have seats on the portfolio company’s board? Are there robust policies in place to mitigate conflicts of interest?

Advisors have a fiduciary obligation to ensure that the funds they recommend align with an ethical framework, considering factors such as social responsibility, environmental impact, and transparent governance.

6. When and How to Incorporate Private Markets into a Portfolio

6.1 Growth or Defensive?

Private markets, while sometimes perceived as a magic bullet for diversification, are not one-size-fits-all solutions. They vary in risk profile:

• Private Credit: Can be structured to produce a steady stream of income and potentially offer some inflation protection through floating rates. It is often discussed as a “defensive” strategy—yet it still correlates to the economic environment and credit conditions.
• Private Equity: Considered a growth component, more closely correlated to equity markets, but with the added complexity of leveraging or focusing on unlisted assets.

Neither entirely removes market risk; both respond to macroeconomic forces—just sometimes on different timelines and with different patterns of return and volatility.

6.2 Determining Allocation Sizing

One of the most commonly asked questions is: “What percentage of my client’s portfolio should be allocated to private markets?” The answer depends on several factors:

• Client Risk Tolerance and Time Horizon: A large allocation to private markets suits those with long investment horizons and a capacity to tie up capital for years.
• Liquidity Needs: If a client may need access to their capital unexpectedly, private market allocations should remain modest or be structured through vehicles offering limited, scheduled redemptions.
• Existing Portfolio Composition: A client with strong exposures to public equities and fixed income may benefit from private credit as an alternative source of yield. Alternatively, a high-net-worth individual might use private equity to enhance growth potential.

Ethically, an advisor should make recommendations that never push a client beyond their comfort zone or investment horizon. The illiquidity premium can be attractive, but not at the expense of a client’s immediate or short-term needs.

6.3 Managing Liquidity Constraints

Private market funds often use limited partnerships or closed-end fund structures that lock in capital for years. However, some innovations (such as evergreen funds) offer quarterly or monthly liquidity windows, albeit typically with certain redemption restrictions. Still, advisors must stress the core principle: private market investing is inherently long-term. Structuring a portion of the overall portfolio to remain readily liquid—via public markets, cash, or short-duration instruments—is crucial to cover near-term expenses and emergencies.

7. The “Opacity” Challenge and the Path to Transparency

A recurring theme in discussions about private markets is their perceived opacity. This stems from several factors:

• Lack of Exchange Listing: With no daily price discovery on a public market, private assets do not have the same degree of continuous transparency as listed bonds or stocks.
• Complex Valuation Methods: In private equity and private credit, managers often rely on external appraisers, or “mark-to-model” techniques that may be updated only quarterly or semi-annually.
• Tailored Deal Structures: Each private debt or private equity deal can differ from the next. Covenant agreements, default provisions, or equity participation structures vary widely.

7.1 Best Practices for Ethical Transparency

Professionalism in recommending private markets involves a thorough appraisal of how valuations are reached and how frequently they are updated. Ethical best practices include:

1. Regular Reporting: Even though valuations might be quarterly, managers should provide timely updates on material changes or significant corporate actions.
2. Independent Valuation Agents: Managers who partner with third-party valuation providers help mitigate conflicts of interest and enhance credibility.
3. Complete Disclosure of Fees: Private market funds commonly have multiple fee layers: management, performance, and sometimes transaction or administration fees. Advisors must request a detailed fee breakdown and present it to clients clearly.

8. Practical Case Study Elements

While the podcast did not dive deeply into specific case studies, its participants touched on how a typical private credit or private equity transaction might be structured. These examples underscore the necessity of thorough underwriting, macro awareness, and relationship-driven deal sourcing:

8.1 Private Credit in Action

• Borrower Relationship: A private credit manager with a robust network may learn that a mid-sized technology manufacturer needs working capital. The manager examines the company’s financial statements, business model, and collateral.
• Negotiating Terms: Based on risk assessment, the manager might structure a senior-secured loan with certain covenants protecting against dividend payouts or additional leverage. This protects the lender if the borrower’s cash flow deteriorates.
• On-Going Monitoring: The manager receives monthly or quarterly updates from the borrower, and if warning signs appear, can proactively renegotiate terms.

8.2 Private Equity Growth Investment

• Identifying a High-Growth Sector: A private equity firm spots a burgeoning consumer healthcare start-up. The firm invests for a 20–30% equity stake to fund expansion in new markets.
• Value Creation Phase: Over the next five years, the private equity firm helps formalize governance, streamline supply chains, and cultivate strategic partnerships. Operational expertise is applied to boost revenue and earnings.
• Exit Strategy: After the business matures and valuations improve, the private equity firm may exit via a trade sale or IPO. Proceeds are returned to investors.

In both examples, the ethical dimension includes confirming the lender or investor has the right to full disclosure, that risk and return metrics are well understood, and that any potential conflicts of interest—such as a manager also sitting on a borrower’s board—are properly managed and disclosed.

9. The Role of Regulatory Oversight and Advisor Responsibilities

Financial advisors bear significant responsibility for safeguarding clients’ best interests. While private market investments are regulated (in most jurisdictions, private funds must register or adhere to certain disclosure standards), they may not face the same breadth of real-time scrutiny as publicly listed stocks or bonds. Thus, the professional advisor must ensure:

1. Compliance with Licensing: Ensure the product provider has the requisite Australian Financial Services License (AFSL) or its equivalent in the relevant jurisdiction.
2. Understanding of Risk Disclosure: Provide clients with product disclosure statements (PDS) or information memoranda (IM) that outline the risks, fees, and liquidity constraints in detail.
3. Monitoring and Review: Even after the client invests, the advisor should continue to monitor the fund and the manager, periodically reevaluating alignment with the client’s goals and risk tolerance.

9.1 Ethical Codes and Fiduciary Duty

Professional associations in finance articulate clear ethical codes that revolve around client welfare, integrity, and diligence. Advisors must conduct ongoing due diligence, remain current on changing market conditions, and provide forthright information to their clients. This extends to explaining why a certain private market fund may be suitable—or unsuitable—given the client’s objectives and constraints.

10. Conclusion: Balancing Opportunity and Responsibility

Private market alternatives can offer compelling returns, unique diversification opportunities, and a more controlled or “smoothed” volatility profile. With the resurgence of inflation and a shift to higher interest rates worldwide, both private equity and private credit strategies have become increasingly relevant. While they cannot entirely decouple from macroeconomic forces, these assets bring fresh dimensions to portfolio construction.

Yet these benefits must be weighed against critical considerations:

• Illiquidity: Clients must be comfortable committing capital for longer periods, particularly in closed-end fund structures.
• Complexity and Fees: The complexity of private investments necessitates thorough advisor due diligence. Fees can be higher than in public markets, and the structure of those fees is not always straightforward.
• Opacity and Transparency: Less frequent valuations demand that advisors insist on third-party audits, robust disclosures, and clarity around manager processes.
• Ethical Implications: Advisors must ensure alignment with their clients’ best interests, thoroughly vet potential managers, and remain vigilant about conflicts of interest and corporate governance issues.

In light of these considerations, the question is less about whether private markets are “good” or “bad” and more about whether they are professionally and ethically suitable for the individual client’s profile, objectives, and risk tolerance. As more investors seek stable returns and diversification away from heavily correlated public markets, advisors equipped with a strong ethical compass and deep professional expertise can guide them effectively into these less-charted territories.

Ultimately, private market investments should serve the client’s goals over the appropriate time horizon. Ethical, client-centered decision-making ensures that when advisors do recommend private credit or private equity, they do so transparently, with clear disclosures, and with a rigorous process that underscores professionalism at every step.

Key Takeaways at a Glance

1. Professionalism and Ethics Come First
   • Always prioritize client welfare, maintain transparency, and clarify fees, risks, and lock-up periods.
2. Define the Investment Profile
   • Private credit is often seen as an income-oriented, lower-volatility asset with floating rates, while private equity targets growth and transformation over a longer horizon.
3. Check the Manager’s Track Record
   • Look for managers who have navigated multiple market cycles, maintain strong relationships for deal flow, and have robust underwriting standards.
4. Manage Liquidity and Timing
   • While private market investments can offer attractive returns, they are illiquid. Clients must genuinely have a longer-term horizon and not require quick access to that capital.
5. Scrutinize Opacity and Demand Transparency
   • Seek evidence of third-party valuations, consistent reporting, and clear governance structures.
6. Understand the Macro Context
   • In environments of rising rates and inflation, private market strategies can help diversify and smooth overall portfolio returns—if the risk-return trade-off remains favorable.
7. Balance Opportunity with Responsibility
   • Not every client or portfolio is suited to these assets. Evaluate carefully before recommending any private market strategy.

By taking these steps and upholding the highest professional standards, financial advisors can responsibly integrate private market alternatives into portfolios in a way that seeks to deliver returns while managing risk ethically and effectively. This approach not only helps meet clients’ long-term objectives but also upholds the advisor’s duty of care, thereby reinforcing trust, credibility, and the integrity of the financial advice profession.

Accreditation Points Allocation:

0.20 Technical Competence

0.10 Client Care and Practice

0.10 Professionalism and Ethics

0.40 Total CPD Points