by Ryan Moeller

What is an investor’s greatest enemy to achieving true wealth? Themselves. 

Human nature prefers simplicity, is impulsive, and prone to the herd mentality. That’s why investors are drawn to Wall Street. The Wall Street players understand this and prey upon simplicity and impulsiveness. So-called financial advisors who profit from fee churning also benefit from the volatility brought about by investor impulsiveness. They have no incentive to change the status quo.

Despite Wall Street’s grip on a large segment of investors, there is a growing movement to break away from the norm and there’s one simple reason for this seachange – RETURNS.

In a previous message, we discussed Wall Street’s outdated 60/40 allocation strategy, which allocates assets between 60% stocks and 40% bonds. In response to the ineffectiveness of the 60/40 rule, there’s been tremendous interest in a new allocation strategy where 40% of a portfolio is dedicated to private investments. Why? Because members of this 40% club have been beating Wall Street returns by a wide margin.

Anticipating the obsolescence of the tired Wall Street model, major university endowments and institutions turned to private investments for above-market returns sheltered from Wall Street volatility and inflation. Private investments including non-venture private equity, venture capital, private real estate, private oil & gas/natural resources, and precious metals have provided the types of returns Wall Street is no longer able to offer and without the volatility.

The private investment firm Cambridge Associates (“CA”) recently published a study finding that private investments have provided the strongest relative returns for decades. Top-performing endowments like the Yale Endowment and other institutions have been long-time allocators to private investment strategies, reaping the benefits of the outperformance. Private Investing for Private Investors: Life Can Be Better After 40(%). (2019, February)

In recent years high net worth individuals (“HNWIs”) and family offices have taken notice of these successful endowments and institutions and are now pivoting towards adding private investments to their portfolios for good reason.

CA’s past analysis indicates that endowments and foundations in the top quartile of performance had one thing in common: a minimum allocation of 15% to private investments. CA data also showed that the top 10% steadily increased their allocations to private investments over the past two decades, exceeding 15% of allocations, in many cases, exceeding 40%.

CA data shows a clear positive correlation between returns and allocation percentages to private investments.

Figure 1 highlights the meaningful returns that institutions with higher allocations to private investments have achieved over the last 20 years. The median annualized return for a greater than 15% average allocation was 8.1%, 160 basis points higher than the group with a less than 5% allocation. This chart also shows the higher the allocation, the better. As seen in Figure 2, the top 10% of performers have steadily increased their allocations over the years to a mean of 40%.

Figure 1

Figure 2

So, what differentiates these successful institutions from the typical Wall Street investors? Private investors are comfortable with a long time horizon, illiquidity, and complexity inherent in higher private investment allocations. They understand it takes time and skill to build a private investment program, but they are compelled by the potential rewards for this extra effort.

Additionally, what has appealed to many of the decision makers at these institutions is the fact that where they lack the necessary experience or knowledge in a particular field, they have no reservations about deferring to the expertise of the principals at these private firms if the trust is there. This level of trust is achievable because private investment firms are typically more transparent and their directors more accessible than their public counterparts, allowing investors to place money in markets in which they’re not completely familiar but where they’re comfortable trusting the decision makers.

Joining this growing 40% club will require a change in investment approach. Investors interested in building multigenerational wealth through private investments with the necessary long view, patience, and ability to act quickly, will stand to benefit not only from the potential for higher returns but also from the tax-advantaged nature of private investments like real estate.

Discover how you can join the 40% club and take your investing to the next level by Partnering with Fall Creek.