June 17, 2024

Bridging the “Alternatives Gap”

Narrowing the Divide Between Institutions and Individual Accredited Investors

June 17, 2024

Bridging the “Alternatives Gap”

Narrowing the Divide Between Institutions and Individual Accredited Investors

Commentary

What is the “Alternatives Gap”?

Canadian pension plans, endowments, and foundations are considered to be among the world’s most sophisticated investors—and for years, one of the reasons they have generated strong long-term performance is that they’ve had access to the unique growth, income, and diversification opportunities offered by private markets.1 Historically, individual accredited investors have lacked access to these kinds of alternative investments. This has created a vast gap—the “Alternatives Gap”—between institutional and accredited investors’ portfolios.

Data shows that large institutions may allocate up to half of their portfolios to private markets. Mass affluent, high-net-worth and very high-net-worth investors, by contrast, allocate less than 3% of their portfolios to private markets. Even Advisors’ and family offices’ most affluent clients—ultra-high-net-worth investors—allocate only 18% to private markets. This could indicate a positive correlation between allocation to private markets and the net worth of the investor.

Who Invests in Private Markets?

Allocation to Private Markets by Type of Investor

Endowments, foundations, and Canadian pension plans lead the way when it comes to allocations to private markets.

What created this gap? A significant root cause is accessibility. Many private market investments require an initial investment in the millions of dollars, an entry point that is simply too high for most individuals—especially if it represents only a portion of their portfolio. Liquidity is also an issue, as many alternative investments require a capital commitment of several years or more. While these issues represent a significant barrier to individuals, they are less meaningful for large institutions, which typically manage large pools of assets, have more predictable liquidity needs, and deal in longer time horizons.

The Case for Alts

Alternative investments may offer three main benefits to portfolios: enhancing returns, generating income, and diversifying risk through a lower correlation to public market assets. These benefits have been proven over a long-term time horizon.6

The reality is that virtually all Canadians have exposure to alternative investments, because we are stakeholders in public pension plans such as Canadian Pension Plan (CPP). CPP allocates nearly 60% of its portfolio to private markets, including 33% to private equity, 7% to private credit, and 18% to real assets like real estate and infrastructure. This is roughly in line with Canada’s other “Maple Eight” pension funds, all but one of which allocate more than 40% to alternative investments.

The Case for Alts

Current Annual Reports (2022/23)

Sources: Annual reports. Where not explicitly cited in annual reports, private credit allocation is approximated by “Level 3” credit assets divided by gross plan investments.

Pensions’ mass adoption of alternative investment support the idea that they can deliver important, complementary benefits to traditional holdings. The question for accredited investors, then, is how best to unlock these benefits for their own portfolios.

Leveling the Playing Field Between Institutions and Accredited Investors

The alternatives landscape is currently undergoing a significant shift, as the investment industry develops innovative new solutions that enable accredited investors to access the world of private markets. Historically, private market investment vehicles tended to utilize closed-ended structures, meaning that investors often had to commit to the investment for up to a decade. As new ideas in the portfolio were vetted and explored, money often sat on the sidelines, uninvested, for one or two years. Then, the investor would be subject to capital calls—periodic requests for the money the investor has committed—which can be unpredictable.

Now, evergreen structures are leveling the playing field for accredited investors. These kinds of solutions may feature lower investment minimums and greater flexibility. For example, the BMO Partners Group Private Markets Fund, which is available to Canadian accredited investors, features monthly subscriptions and redemptions with notice.7 This enables investors to add to their position when desired and access their money when needed.8 Together, these are pivotal developments in making alternatives accessible to a much wider array of investors. Looking ahead, we view accredited investors as a major growth area for private markets.

Private Markets. Simplified.

BMO GAM’s Alternatives team is focused on designing solutions that help accredited investors achieve their investment objectives, including improving access to private markets for accredited investors. Benefits of our solutions may include:

  • Periodic subscriptions and redemptions with notice8
  • No capital calls
  • Relatively low minimum investments
  • Ability for capital to compound within the fund itself rather than facing reinvestment risk
  • Registered account eligibility (i.e., RRSP, RDSP, RRIF, TFSA.)9
  • Investing, not committing

Investing with a Trusted Partner

In private markets even more than public markets, who you invest with matters. Data shows that the difference in performance between the top and bottom quartile alternative investment managers is significantly wider than in public markets. That is, the stakes for selecting the right manager are noticeably higher for alternative investments.

Manager Dispersion Over 10 Years – Public vs. Alternative Managers

Over the past 10 years, the difference in performance between the top and bottom quartile alternative investment managers has been significantly wider than in public markets.

Sources: Public markets: Morningstar data; results are based on 10-year total returns as of April 30, 2023. Alternatives: Preqin data; based on IRRs from global managers from 2011–2020. Based on chart from JP Morgan.

As a result, the ability to effectively perform diligence on managers and strategies is a requirement for anyone considering alternative investments. Institutions like endowments and pension funds generally have large teams that are able to conduct extensive research on private market managers, their processes, and their performance. In contrast, many Advisors rely on their Manager Research teams or equivalent to screen opportunities on their behalf.

BMO GAM’s alternative investment solutions help to solve these problems by providing an additional layer of diligence. Where we have the expertise and demonstrated track record, we develop proprietary product in-house. In areas where we don’t have proprietary solutions, we take a research-first approach to identifying global managers, partnering with them to fit the needs of Canadian accredited investors.

The BMO Partners Group Private Markets Fund is an example of the latter. After a year-long selection process, Partners Group was selected by BMO GAM because of its 30 years of experience in private markets—including private equity, private credit, real estate, and infrastructure—as well as its 20-plus-year track record managing evergreen funds and over $147 billion in assets under management.10 Then, BMO GAM intentionally designed a solution suitable to the Canadian market to capture the benefits of alternative investments for its accredited investors client base.

Through funds like the BMO Partners Group Private Markets Fund, Advisors can narrow the “Alternatives Gap” in their clients’ portfolios, enabling them to access the benefits of private markets—potentially enhanced returns, income, and diversification—previously available only to institutions.

For more information

Sources

Footnotes

1 Chartered Alternative Investment Analyst Blog, “Impact Alternatives: Enhancing Portfolio Returns and Global Good,” February 3, 2022.

2 CPP Annual Reports (2019, 2022) (CPP 2022 private credit percentage is from the total in figure 10.3.2: Terms to Maturity).

3 CDPQ Annual Reports (2016, 2019, 2022). While CDPQ does not divide private credit from public credit, it has noted private credit was a key driver of positive fixed income performance in 2016 and 2022 (cdpq.com).

4 BCI Annual reports (2015–16, 2018–19, 2021–22). While BCI does not divide private credits from public fixed income, it has noted that a net $2.1Bn was deployed into private credit in 2021–22.

5 Bain & Company, Global Private Equity Report 2023; Preqin, GlobalData.

6 Chartered Alternative Investment Analyst Blog, “Impact Alternatives: Enhancing Portfolio Returns and Global Good,” February 3, 2022.

7 Investors can subscribe on a monthly basis and periodically adjust their position subject to redemption restrictions, early redemption fees and redemption delays.

8 Redemption requests may be subject to certain restrictions, early redemption fees and redemption delays.

9 Subject to certain regulatory conditions.

10 Unaudited, inclusive of all Partners Group affiliates, as of December 31, 2023. Assets held globally.

Disclaimers

BMO Global Asset Management is a brand name under which BMO Asset Management Inc. and BMO Investments Inc. operate.

 

The attached material is provided to you on the understanding that you will understand and accept its inherent limitations, you will not rely on it in making or recommending any investment decision with respect to any securities that may be issued, and you will use it only for the purpose of considering your preliminary interest in investing in a transaction of the type described herein. An investment in the BMO Partners Group Private Markets Fund (the BMO PG Fund) or any other alternative fund securities described hereby is speculative. A subscription for units of the BMO PG Fund or any other alternative fund securities should be considered only by persons financially able to maintain their investment and who can bear the risk of loss associated with an investment in the BMO PG Fund or an investment in any other alternative fund securities. Prospective investors should consult with their own independent professional legal, tax, investment and financial advisors before purchasing units of the BMO PG Fund or any other alternative fund securities in order to determine the appropriateness of this investment in relation to their financial and investment objectives and in relation to the tax consequences of any such investment. Prospective investors should consider the risks described in the confidential offering memorandum (OM) of the BMO PG Fund or in the relevant documentation for the offering of any alternative fund securities before purchasing units of the BMO PG Fund or any other alternative fund securities. Any or all of these risks, or other as yet unidentified risks, may have a material adverse effect on the BMO PG Fund’s business, another alternative fund’s business and/or the return to investors. Among other things, see “Investment Objective, Investment Strategy and Certain Risks” in the OM of the BMO PG Fund.

In addition to the risks described in the OM of the BMO PG Fund, the BMO PG Fund will bear the risks associated with the Partners Group BMO Master Limited (Master Fund) in proportion to the amount of the BMO PG Fund’s investment in the Master Fund. Prospective investors in the BMO PG Fund should therefore carefully consider the risks described under “Certain risk factors”, “Business and structure related risks”, “Adviser related risks”, “Investment-related risks” and “Limits of risk disclosure” in the OM of the Master Fund.

 

“BMO (M-bar roundel symbol)” is a registered trademark of Bank of Montreal, used under license.

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