Just Don't With Private Assets

Barron's had a very quick look at the recent popularity of private assets to try to figure out whether investors should wade into the space. One quote that caught my eye was that over the last ten years, private equity has returned 15.2% annualized versus 12% for the S&P 500. They didn't cite a source for that 15.2% number. 

If you look at the sectors that make up the S&P 500, there are a couple that very frequently will outperform the index over rolling ten year periods, there are a couple, maybe several, that will likely go up less than the index pretty reliably and a bunch in the middle that might be coin flips in a random ten year period. Tech is a very good bet to regularly outperform the S&P 500. Consumer discretionary is another one that pretty reliably outperforms for ten year periods, not the last couple though after getting whacked pretty hard in 2022 though. 

That of course speaks to the tradeoff. The sectors that tend to go up more, will also likely go down more. I would imagine that once the new communications sector begins to get ten year rolling periods under its belt, it too will outperform in a similar manner with the same tradeoff. 

You don't buy a soda stock and a laundry detergent stock expecting long term outperformance. The returns can be fantastic thanks in some measure the dividends they usually pay. Here's an exception that came as a result of the Financial Crisis. The blue line is the Consumer Staples Sector SPDR. As you might expect, staples went down much less in the Financial Crisis as well as in 2022.

Of course it has unsurprisingly lagged the S&P 500 more recently. With communications, the top three holdings are Meta, Google and Netflix. Maybe they will not outperform going forward, who knows, but those names don't offer low volatility or high yields, you buy them because you believe they will outperform. 

So, not even going to the individual stock level, just sticking with sectors, if the extra 320 basis points compounded that private equity gave is appealing, you could probably do just as well if not better with a couple of sector decisions while avoiding the extra expense and liquidity issues of private assets. 

This would work going a little narrower than sectors, into industries or themes. This is less reliable though. Semiconductors as an industry is a decent bet to outperform more often than not. The food industry, probably not.

SOXX and SMH are the two largest semiconductor ETFs I am aware of and PBJ is a food and beverage ETF with an all-timer of a symbol. 

If you use individual stocks and hold them for long periods, then odds are pretty good you have a couple that are miles ahead of the market and a few more that are lagging behind. The focus shouldn't be on how each individual holding does, assuming there aren't negative fundamental developments, but how they all blend together. As we've discussed in other posts recently, some holdings might more reliably have higher returns providing a disproportionate amount of the portfolio's growth while other holdings might provide downside protection and a disproportionate amount of yield to help smooth out the ride. 

Another snippet from Barron's was the suggestion from Thad Davis of Aureus Asset Management to allocate 7% of a portfolio to private credit to get a 7% spread over SOFR which works out to 11-12%. That's Davis talking, I don't know but assuming those numbers are accurate, I won't say there are plenty of places to get that kind of yield but there are some. And a suggestion of 7% allocated is not like the suggestions to put 25% into managed futures, 7% is reasonably modest. A 3.5% allocation to two different catastrophe bond funds for example would be very close in yield to what Davis is citing and again, they will be cheaper and not have liquidity issues like private assets do. 

For the most part, I think these private asset investments being made a available to retail-sized investors are preying on some sort of emotion. Maybe appealing to vanity or allowing access to something the that appears to be exclusive or sophisticated but the expense and liquidity issues to me are not worth it. And we haven't even gotten into how they price the assets on their books, google the term volatility laundering for more. 

And on a personal note, we got the graphics done for the new Engine 86 which is our primary structure fire engine.

It is very similar to the new wildland engine we got a couple of years ago. I say this all the time around the firehouse but I can't believe we have a fleet like this. 

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.