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Some industry leaders envision private assets becoming the third major asset class for average investors, alongside traditional stocks and bonds.

Private assets offer added diversification and potential for enhanced returns. But they come with high fees, big risks, and liquidity restrictions that might keep you from selling your investments when you want. They need to be assessed carefully, and they鈥檙e not for everybody.

鈥淧rivate investments are certainly valid components to include in portfolios,鈥� says Dan Hallett, vice-president of research at HighView Financial Group, an investment counsel firm that includes private assets in some client portfolios.

鈥淭hey can enhance and diversify a portfolio and add to returns,鈥� says Hallett. 鈥淏ut it is not a slam dunk. They have risks that are not as obvious as for traditional stock and bond investments.鈥�

Promoting private assets

The private asset push is being led by some of the world鈥檚 largest and most prominent investment firms, which are partnering with or acquiring private asset firms with specialized skills and successful track records.

Firms leading the聽drive include BlackRock, the world鈥檚 largest investment firm (which acquired Global Infrastructure Partners) and Vanguard Group, the index fund pioneer (working with Blackstone and Wellington Management).

In the U.S., investment firms have begun using private assets as a five to 20 per cent component in 401(k) target date funds for average investors. (U.S. 401(k) plans are similar to Canadian RRSPs. Opening these U.S. plans to private assets was facilitated by a recent executive order from U.S. President Donald Trump.)

In Canada, private assets are heavily used by the big public-sector pension plans known as the Maple Eight, but the push into average investor portfolios is at an earlier stage than in the U.S. So far with Canadian retail investing, they are mostly offered just to relatively affluent 鈥渁ccredited investors鈥� who meet specific wealth or income criteria.

Firms offering them in Canada include: Mackenzie Investments (partnering with Northleaf), Wealthsimple (with Sagard and LGT Capital Partners), BMO Global Asset Management (with Partners Group), Purpose Investments (with Pantheon, Apollo and Bluerock), and CI Global Asset Management (with multiple partners).

Private assets are difficult to assess

Private asset proponents tout the opportunity to enhance returns while diversifying beyond the limited confines of tradable markets.

But private assets also come with high risks, hefty fees, and withdrawal restrictions.

Private asset firms generally charge management expenses ranging from about 1.25 per cent to 1.75 per cent, plus there is often a performance fee of 10 to 15 per cent of returns.

Added to that is the fee charged for advice by your financial adviser, which is typically one per cent and sometimes more. Additional fees and costs may be embedded into the investments themselves instead of being charged at the fund level.

Private asset funds usually come with some form of withdrawal restriction. (Five per cent of fund assets in aggregate per quarter is a frequent limit.) Don鈥檛 invest funds that you might need to liquidate quickly.

Some of the heightened riskiness comes from the fact that private investments tend to be in companies that are smaller and less established than their public stock and bond market counterparts.

Also, private asset managers tend to use a lot of debt, which can be layered in at the operating company level or at the fund level. This added debt tends to magnify returns but also amps up risks.

With stock market investments, investors use price volatility (measured by the standard deviation) as a key indicator of riskiness.

But private assets have no market prices, so valuations must be estimated. Common methods of estimating valuations tend to smooth out fluctuations, resulting in a lower measure of volatility compared to public market metrics. As a result, low private asset volatility measures are misleading.

鈥淵ou have to treat them as riskier but the difference (compared to public market investments) is the risk is not evident in the prices that you see every month or every quarter,鈥� says Hallett. 鈥淚t鈥檚 harder to see but the risk is there and you need to treat it as such when you鈥檙e figuring out how much to put in your portfolio.鈥�

Generally, you buy private asset funds through an adviser who you depend on to properly assess them, which isn鈥檛 easy.

Hallett is responsible for private asset due diligence at his firm and says it is far harder than for public market investments.

He likens it to the 鈥渃hild I worry most about,鈥� which 鈥渄oesn鈥檛 mean they don鈥檛 turn out fine.鈥�

In assessing a private asset fund, Hallett starts with the assumption of 鈥済uilty until proven innocent.鈥� He says: 鈥淵ou have to dig to find the negatives because they won鈥檛 be put in your face.鈥�

How much private assets should you add?

When adding private assets to your portfolio, a modest amount goes a long way. BlackRock CEO Larry Fink recently suggested 20 per cent as a potential standard private asset allocation in an average investor鈥檚 overall portfolio.

In my view, 20 per cent makes sense as an upper limit, and only in the right situations.

You need to have a long-term horizon, be able to tolerate illiquidity for that portion of your portfolio, have a moderately high-risk tolerance, and you must have confidence in your adviser鈥檚 ability to pick good private asset investments.

If those conditions don鈥檛 apply, invest less or bypass private assets entirely. A portfolio that sticks just with stocks and bonds works just fine: 鈥淚t is not obsolete,鈥� says Hallett.

Different types of private assets have different characteristics. The main categories are: private equity, private credit, infrastructure, and directly-owned real estate.

Private equity is a higher expected return/higher risk investment compared to average stock investments. Private equity funds typically buy a company, attempt to improve it in some way, then try to sell it for a gain.

These investments tend to be smaller and less established and therefore riskier compared to the stocks that make up major stock market indices. Private equity firms frequently add a lot of debt to the mix (often using private credit).

Private equity has generally performed well over the last decade or so compared to stocks, but there is now a large backlog of investments that private equity firms are trying to sell.

Generally, they are finding it a challenge to sell at the prices they target. That overhang appears likely to dampen return prospects somewhat over the next several years.

Private credit can enhance yields, but the added risk can be substantial.

According to the IMF Global Financial Stability Report of April 2024, private credit borrowers tend to be riskier than is typical even for riskier forms of publicly-traded bonds like high-yield debt.

Private credit can play a useful role in average portfolios, but it is no substitute for the reliable investment grade bonds that form the bulwark of most average investor fixed income portfolios. Use private credit cautiously and sparingly.

Direct investments in infrastructure and real estate can be used to generate income and capital appreciation.

They might substitute for dividend stocks and REITS in portfolios. They often come with only moderate purported riskiness, although sizable debtloads can bump up risk levels higher than you might expect.