By Elizabeth O'Brien

Chances are, you've heard the pitch: Boost your returns and diversify your portfolio by investing in private markets. But does it live up to the hype?

It can, if you're very selective, but there are major drawbacks and few good ways for investors without significant wealth to participate.

Private markets are booming and expected to reach more than $15 trillion this year, up from $10 trillion in 2021, according to S&P Global. Private equity accounts for over half of the total, S&P says, but private credit/debt and real assets -- like commercial buildings and utilities -- are growing rapidly. A recent survey by ISS Market Intelligence found that 64% of advisors who invest in alternatives report that they used private credit.

The biggest players in the space include Blackstone, KKR, Ares Management, and Apollo Global Management, which now manage trillions in private assets. The companies are always looking for new capital to fund buyouts, extend credit, and acquire private assets. And as more companies stay private for longer, the pot of private assets keeps growing.

Historically, private equity has been the purview of the ultrawealthy, but that is slowly changing. While some private investments are open only to wealthy "accredited investors" who meet income and asset criteria set by the Securities and Exchange Commission, new exchange-traded funds like BondBloxx Private Credit CLO offer all investors exposure to private credit. Private-equity firms also hope to make inroads in the $9 trillion 401(k) market.

Whether it's a good idea depends on factors like the quality of the underlying assets, and there are many drawbacks to consider.

Most private investments are illiquid, requiring you to tie up your money for long periods. Funds could also be subject to "gating," the practice of managers limiting investor redemptions after requests hit a certain limit -- a problem that investors in Blackstone's retail real estate fund confronted in 2022. This could be a particular issue for retirees who need to regularly withdraw money from their portfolios for living expenses.

For the increased risk, private assets generally promise higher returns than publicly traded securities. Pricing is done through an appraisal process, and returns come from changes in the appraised value over time, says Hal Ratner, head of research at Morningstar Retirement, who urges investors to be cautious in the space.

Private equity returned a median annualized 15.2% over the 10-year period ended in 2023, according to the American Investment Council, versus 12% for the S&P 500 index. But the private-equity numbers are aggregate figures that mask wide disparities by individual firms. Other studies have found diminishing returns in recent years and less of an edge over the public market, depending on the time period.

Thad Davis, president and CEO of Aureus Asset Management, says that the private credit he uses for clients offers a seven-percentage point spread over the Secured Overnight Financing Rate, or SOFR, or 11% to 12%. "These are very good income generators," he says.

His firm's current recommendation is that 7% of overall client portfolios should be in private credit, which they vet closely. Rather than act as a replacement for a standard portfolio of stocks and bonds, it's a diversifier within such a portfolio, he says.

Ratner agrees that the case for diversification is stronger than the case for noncorrelation when it comes to private investments. While stocks and bonds have moved similarly in recent years, lessening in some eyes the need for a traditional stock and bond split, it's hard to say that private investments would do otherwise, Ratner says. Since private assets don't price frequently, it's hard to track their correlation with public counterparts, he notes.

Investors considering private investments should make sure they understand the liquidity provisions -- that is, how soon you can get your money out; the fees, which can be considerable; the manager's track record; and, in the case of private credit, the credit quality of the underlying assets.

Also, make sure the advisor pitching the product is acting as a fiduciary required to put your interests ahead of their own in the transaction.

There's another way to tap into the space: owning the stocks of companies like Blackstone, Apollo, and KKR. Bear in mind, however, that these companies are relatively opaque and sensitive to changes in interest rates, which impact their underlying asset values and financing costs. Private-asset values have also soared, and lots of money is now chasing what's left.

Write to Elizabeth O'Brien at elizabeth.obrien@barrons.com

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February 07, 2025 21:30 ET (02:30 GMT)

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