A terrible reason to invest in something is because you have less information about its value, but that is precisely the argument Ken Novak makes in a recent InvestmentNews column entitled “Private markets belong in every advisor’s toolkit .” Novak writes:
One of the compelling reasons to include private market assets in client portfolios is as a potential hedge against volatility. Unlike public equities, which are updated daily and can swing due to headlines, technical factors or investor sentiment, private investments are typically revalued only during significant events like a capital raise or a sale. This means they’re less correlated with matters that affect public markets, which can help smooth out portfolio performance during turbulent times. As public markets grow more unpredictable, private assets may offer a powerful tool for diversification.
Here at Marotta we do not recommend investments that are not publicly priced and traded like hedge funds, private offerings, or nonpublic limited partnerships. The value of these assets is often assumed to be their purchase price until the management company provides a new value. However, their liquidation value might be only a fraction of the investment’s presumed value. Furthermore, investments that are not publicly priced and traded cause many conflicts of interest when it comes to reporting and billing. If new clients of our firm own such investments when they come onboard, we will help them determine if they should continue to hold them, but we do not normally recommend purchasing them because of their inherent difficulties.
In fact, we have nine rules which, when followed, better safeguard your money. Private equity like Novak describes goes against Safeguard #3: “Insist on Publicly Priced and Traded Investments.”
I have seen private equity that was priced at $250,000 for many years only to have the equity priced at zero in a single day. Was that equity volatile? Of course it was. Was it stable? Of course not. Did it lack technical correlation to other investments? Well, technically yes, but only because it lacked any accurate pricing at all. Private equity’s smoothed prices are not the same as stability.
As an analogy, a thermometer that is only checked once a year does not create a steadier temperature throughout the year.
When someone says that a private holding is less volatile, they may only mean that no one knows what price you could sell it for.
In the markets, you have both a bid (the highest price a buyer will pay) and an ask (the lowest price a seller will accept). This bid-ask spread is how much it costs to buy and sell the asset. One way of describing private equity is that the bid-ask spread is often too large, and therefore you should neither buy nor sell the asset.
The problem is exacerbated in retirement. A retirement portfolio is not just a collection of holdings intended to look good on a statement. It exists to fund spending. Retirees need assets that can be sold to generate cash for living expenses, rebalancing, charitable giving, taxes, and eventually required minimum distributions from traditional retirement accounts. Illiquid assets make that more difficult.
Without publicly priced securities, you do not have an accurate paper valuation, and you cannot spend what you do have until there is a market where you can sell the investment.
A retirement portfolio should hold investments you can price, sell, and spend. If an asset lacks a real bid and ask pirce, if you cannot be confident of its fair value, and if selling it is difficult when cash is needed, then its place in a retirement portfolio is highly questionable. That is why Marotta’s safeguard still holds up well today: insist on publicly priced and traded investments.
Whenever I see financial advice against what we would recommend I look to the source of that financial advice. Ken Novak is the Director of the Private Institutional Client group at Raymond James, so his advice to purchase his own product is not surprising. And this is one of the many reasons why you should also insist on having an independent fee-only financial advisor.
If you like the life experience of only sort of knowing what your investments are truly worth, you can achieve the same benefit by investing in pubicly priced and traded investments and then taking Bogle’s best advice: Don’t peek!
Photo by Tim ten Cate on Unsplash. Image has been cropped.
