As stock markets, gold, housing and other key assets come under pressure, it’s tempting to look for investments that might offset declines.
Financial companies have increasingly been pushing private equity and credit as options that used to be out of reach for mom-and-pop investors, billed as a way to hedge against market swings while offering the potential of higher returns.
But growing rumbles in the segment have revealed what some say are clear drawbacks for retail investors, as losses in private assets have forced some firms to halt withdrawals and raised questions on the stated value of their holdings.
“There are real concerns,” said Amy Arnott, a portfolio strategist at Morningstar Inc.
“There has been a lot of aggressive marketing to individuals encouraging them to get exposure to private equity and private credit, and we are seeing some cracks emerge.”
Those cracks have included some very public bankruptcies in U.S. private markets, including auto parts supplier First Brands Group, which have raised concerns about loan quality in private credit.
In Canada, turmoil has been especially pronounced in private real estate funds. Firms like Trez Capital Fund Management, Centurion Asset Management Inc., Avenue Living Asset Management Ltd. and many others have either halted or limited withdrawals from their funds in recent months.
According to Bloomberg, about $30 billion in assets in Canadian funds have been gated, meaning investors can’t take their money out.
There are also rising worries around the supposed valuations of companies held in private equity, such as in the software sector where artificial intelligence threatens to upend software subscription businesses by making it easier to automate tasks and create alternatives.
It’s not so clear, though, what’s really going on because of the nature of private markets.
Private firms don’t need to publish quarterly reports and don’t trade on stock exchanges, which proponents say gives room to look longer term to build or turn around companies, shielded from the more impatient and unrelenting public markets glare.
But while being private means company valuations might not change as fast, it doesn’t mean investors are actually getting a hedge on what’s happening in public markets, said Jason Pereira, a financial planner at Woodgate Financial Inc.
“The belief that the public market and private markets aren’t related is nonsense.”
He said Canadian firms have been slower than U.S. firms in expanding access to the alternative space, making the prospects worse for those considering entering.
“We are late to the game, with basically the push toward (alternatives) having happened pretty heavily in the last several years, while they’re simultaneously starting to implode.”
Higher fees and the risk of money getting locked in for long periods make the investments unsuitable for most retail investors, he said.
“Individuals are not pensions,” said Pereira.
“Life changes, and we need access to money all the time.”
But firms that offer access to private markets can still play a useful role to help diversify investments, as long as investors are prepared.
Wealthsimple Inc., which launched a private credit fund in 2023, ensures all potential investors in the segment actually talk with an adviser to make sure they know the details, said Steve Katuska, the company’s senior director of investment research.
He said the volume of client questions is very high these days, and that Wealthsimple is spending a lot of time focusing on education and meeting client redemptions.
“The range of outcomes now is wider than it’s been in a long time, and so I do understand investors being concerned about it,” said Katuska.
Wealthsimple’s private credit fund returned 3.1% last year, well off the 10.6% from a year earlier. It’s a drop seen at other funds like Mackenzie Northleaf private credit, which returned 4.4% last year after 9.1% a year earlier.
The return is well below long-term expectations, but within the range of outcomes Wealthsimple expects, said Katuska.
He said Wealthsimple has met redemption requests, but that it’s reasonable for other funds to restrict withdrawals to avoid having to sell off assets during a down market to meet withdrawals.
“The design of private markets is to hold them for the long term and to sort of help people navigate the ups and downs in the volatile period.”
Part of the concern though, is that the days of high returns in private markets have already passed, or will be harder to achieve, as the many new entrants have crowded in and pushed down returns.
While there are opportunities for higher returns, it might not be worth the liquidity and credit risks, said Arnott.
“There are enough negatives in this area that unless you really have significant wealth, say, more than US$5 million or so, I don’t think there’s any reason that you need to have exposure to this type of asset.”