Many individual investors often look at public markets like they are the only game in town to make money and meet their financial goals.

But with lofty valuations of public companies and depressed bond yields, the traditional 60/40 stock-to-bond portfolio has been thrown to the wayside, so the next generation of investors needs to pivot away from their parents’ investing methods.

While they can still try to squeeze all the juice possible out of the market, the most sophisticated endowments and institutions are looking elsewhere.

Institutions understand that value is often created in the early stages of a company’s growth, before it is publicly traded.

As a result, institutional managers seek out and invest in private markets and alternative assets — like private equity, venture capital, real estate and more — where opportunities exist for better returns with lower volatility and without taking on excess risk.

For example, over the last 30 years, Yale University’s investments in non-traditional assets grew to greater than 70%, from less than 20%, by leveraging venture capital, private equity, hedge funds, etc.

This “endowment model,” created by the late Dr. David Swensen of Yale, started the shift of endowment portfolios into illiquid private investments, and is credited with generating $20 billion in excess returns for the university. (Swensen, a PhD, was an institutional investor, endowment fund manager and philanthropist. He was the chief investment officer at Yale from 1985 until his death in May 2021.)

Right now, institutional investors have more than 55% of their assets allocated to alternatives largely due to their return potential, diversifying power and lower volatility. Meanwhile, retail investor allocation remains in the low single digits, because of historical access constraints.

With this in mind, it’s important for these next-gen investors to think about how they can close that gap by increasing allocations to alternatives. In the past, investors had to network for opportunities and build the team and infrastructure to invest in private markets.

Today, new technology platforms make it simple for individual investors to invest directly in alternative assets.

There are plenty of recent examples of successful on-ramps offering accessibility to new asset classes such as cryptocurrency, art and early- and late-stage private companies. With easily accessible options to gain entry into alternatives, investors can now seek out a holistic allocation strategy to invest in private market assets beyond traditional sources.

To stave off the volatility of inflation, rising interest rates and geopolitical uncertainty, next-gen investors are increasingly allocating to alternatives, which represent a great long-term investment due to their low correlation with and lower volatility compared to public markets. An estimated 81% of investors expect their allocation to alternatives to increase by 2025.

However, investors need to know what to look for when evaluating their investments.

I believe active fund managers are critical. Fund managers are good stewards of capital because they actively manage the portfolio by being on the board, participating in strategy sessions, hiring strong teams and increasing value all the way through an eventual exit. They nurture the companies they invest in to encourage their success and capture “private market alpha,” or the outsized returns that often occur when exposed to breakthrough companies.

There are always risks to consider when investing in the private markets. Those include opaque market information, illiquidity with longer-term hold periods, high investment minimums and the large variance in performance between top and bottom managers in alternative asset classes.

New entrants into the alternative investing space should start with funds or fund-of-funds that are found through reliable sources, making smaller contributions to build up toward their target allocation. Diversifying investments across different funds, asset classes, geographies, sectors, stages and vintage years can also help mitigate risk.

The number of alternative investment strategies available is growing rapidly, with new offerings introduced all the time. There are now hundreds of strategies globally and this number will only increase as new products emerge due to advances in financial technology.

Investing in alternatives offers investors options beyond what’s available in public markets, which can be useful for tailoring risk/return profiles or meeting specific goals such as preserving capital during times of market volatility.

— By Logan Henderson, CEO and founder of Gridline