Navigating a volatile market can be difficult. The level of uncertainty related to inflation, rising interest rates, high private asset valuations and geopolitical risk are putting markets under significant pressure.
Most people think about downside protection by moving investment portfolios into cash. But cash holdings make close to no interest and they lose purchasing power when prices rise during inflationary periods. One dollar buys less than before, leading to negative returns.
Buying the Dip
You may have heard the term “buying the dip,” which refers to how increasing volatility becomes an opportunity to acquire assets at a lower price. Market downturns that result in mark-to-market losses present an opportunity to buy cheaper assets that profit when the market rebounds.
The conventional wisdom was that private markets follow public markets with a six-month lag. This trend is accelerating with transactions that were closing at a billion dollars a few months ago now often closing at half the value.
A high valuation is great for the company that closed the transaction, but it now has a lofty valuation to grow into during potentially difficult markets.
If you could invest in the same company at half the price, would you?
Investors deploying capital now are entering the investment at a compressed valuation that lowers the cost basis, which may provide the same or better returns with lower hurdles, commonly referred to as the goal posts. A 3x return on a $500 million investment looks very different from a 3x return on a $1 billion or greater investment.
Taking a Long-Term View
Having a sound investing strategy and allocation plan allows you to select the right asset class to enter when volatility is introduced, and prudent investment behavior and a long-term outlook are key to the preservation and growth of your investment portfolio in all market cycles.
Sound investing requires a long-term strategy, and Warren Buffett has a great perspective for how you should view your portfolio.
“It’s exactly the same way as if you are going to buy a farm,” he said. “You would not get a price on it every day and you wouldn’t ask whether the yield was a little above expectations this year or down a little bit. You’d look at what the farm was going to produce over time.”
Alternative investments take this long-term approach to heart. Just look at the dot-com crash of the early 2000s. In the decade following that period, the public market equivalent index’s annual return fell to 0.08% while private equity maintained a robust 7.5% average.
Alternatives offer two great benefits to counter the movements in the public market:
- Low correlation – One of the greatest advantages that alternatives offer is low correlation with traditional asset classes. When the stock market is under pressure, commodities, for example, could be performing well.
- Lower volatility – Since alternative investments are less exposed to broad market trends, the impact of volatility can be lower.
Many investors — especially those in the “Next-Gen Wealth” category — are overwhelmingly steering their individual portfolios toward alternative investments in order to stave off the volatility of inflation, rising interest rates and geopolitical uncertainty.
Deploying capital with active fund managers in the private markets is the best way to realize these outsized returns and offers a greater chance of exposure to breakthrough companies (sometimes referred to as “capturing private market alpha”), while providing diversification across geographies, sectors, business models and theses.
Experienced fund managers not only are great at selecting companies to invest in, but the true value comes from everything that happens with the portfolio after the initial investment. This includes board work, hiring strong teams, allocating capital in follow-on rounds and working to get exits.