In the previous edition of Poseidon Market Foresight, we showcased a captivating array of data and trends related to billionaires. Having achieved remarkable feats and amassed considerable fortunes, how do these billionaires leverage diverse investment strategies to safeguard and enhance their wealth? Furthermore, what unique investment strategies do they employ that could serve as valuable insights for us to incorporate into our personal investment portfolios? In this edition of Poseidon Market Foresight, we will delve into the investment tools commonly utilized by billionaires, uncovering their exclusive investment channels and fee advantages along the way.

Alternative Investments: Rising in Popularity Among Billionaires' Portfolios

While the lifestyles of the wealthy and ordinary individuals may seem vastly different on the surface, the investing strategies of the richest 1% often bear striking similarities to those adopted by regular investors. Despite their immense fortunes, a considerable portion of their wealth finds its way into public markets, with traditional asset classes such as stocks and bonds occupying a prominent position in their portfolios. This is not too dissimilar from the investment composition of the average investor. According to the "Global Family Office Report" published by UBS, the surveyed family offices have allocated 55% of their funds towards traditional asset classes, with nearly one-third of their total capital invested in stocks.

However, what truly distinguishes the portfolios of billionaires apart is their unique allocation in alternative markets. Whether it is hedge funds, private equity, or venture capital, they actively engage in these segments to diversify their portfolios and mitigate risks. In accessing investment opportunities, billionaires possess unparalleled advantages, leveraging their extensive social networks to gain early access to promising investment prospects. Additionally, their investment teams play a pivotal role guiding them in screening and evaluating potential investment projects, thereby facilitating informed decision-making.

According to the UBS report, billionaires are increasingly diversifying their investment portfolios. Apart from allocating 55% of their funds to traditional asset classes, they have also channeled a considerable amount of capital into alternative markets. More precisely, 19% of their funds are invested in private equity funds, 13% in real estate, 7% in hedge funds, and 2% in private credit. It is noteworthy that private equity funds have particularly piqued the interest of high-net-worth individuals. Whether it is through direct investments or via funds of funds, the share of private equity funds in billionaires’ portfolios has been steadily climbing each year.

In contrast, ordinary people encounter significant challenges in gaining access to these investment opportunities. The private equity market typically imposes stringent minimum capital requirements, deterring many ordinary investors. For example, in the United States, most private equity funds have rigorous qualification criteria for investors. Qualified investors must possess a net worth of at least $1 million or an annual income of at least $200,000. Similarly, in Hong Kong, private equity investments have comparable thresholds, requiring investors to possess assets of a t least HKD8 million and attain Professional Investor status before they can proceed with investments. However, for some top−tier boutique private equity funds and hedge funds in the industry, the minimum entry requirement can exceed USD10 million.

High-net-worth individuals, on the other hand, benefit from their substantial capital, allowing them to lock in funds in private equity funds for extended periods without worrying about short-term liquidity needs. This advantage enables them to better accommodate the longer investment horizon associated with private equity funds and reap the full rewards of capital appreciation.

For billionaires, the allure of the private market lies in its capacity to diversify their investment portfolios. Through the private market, investors can gain access to innovative and exclusive investment opportunities that are scarce in the public market. As depicted in the figure below, when investors allocate varying proportions of funds in the private market, they can achieve reduced volatility in their portfolios. As investors increase their allocation to private equity and private credit funds, the standard deviation of the investment portfolio gradually decreases, indicating improved risk management. Simultaneously, investors can achieve superior risk-adjusted returns. As the investment proportion in private equity and private credit funds rises, the portfolio’s Sharpe ratio—a measure of additional returns per unit of risk taken—also increases accordingly.

Private market investments present investors with an opportunity to achieve higher returns while mitigating risk. Consider private equity funds, for instance. Typically, these funds target unlisted companies that are either in their early stages of growth or possess specific growth prospects. Given that the public market has not fully recognized the growth potential of these companies, private equity funds have the advantage of acquiring high-growth investment targets at reduced costs. As these companies evolve and mature, investors stand to enjoy substantial capital appreciation. Moreover, the inherent illiquidity of the private market offers investors a liquidity premium. This serves as compensation for the risk associated with limited liquidity, often resulting in higher returns than those offered in the public market.

Hedge funds, as an alternative investment avenue, also present attractive return potential. Hedge funds deploy a diverse range of investment strategies, including event-driven, statistical arbitrage, and macroeconomic strategies. This diversity enables them to adapt to market fluctuations and capitalize on various investment opportunities, ultimately delivering higher returns. Furthermore, through hedging strategies, hedge funds can mitigate certain market risks, ensuring the stability of their returns. This effective risk management allows hedge funds to maintain robust performance even during volatile market conditions.

In recent years, the private market has witnessed the emergence of new investment vehicles, including private credit and secondary market investments. These emerging markets have not only broadened investors' options but also enriched the investment landscape of the private market. In our previous Poseidon Market Foresight, we also provided a detailed analysis of the mechanisms underlying these alternative investments.

Fee Advantage: Economies of Scale Achieved through Institutional Size

Besides having an edge in selecting investment products, billionaires also enjoy greater bargaining power when it comes to transaction costs due to their vast wealth. Each investment transaction incurs associated fees, and frequent trading can inflate these costs, thereby reducing investment returns. Because of their size, billionaires are often treated similarly to institutional investors, who generally enjoy lower transaction costs compared to individual investors.

Take the US bond market as an example. According to data from the Financial Industry Regulatory Authority (FINRA), smaller transactions often come with higher costs. The chart below clearly illustrates the transaction costs, which represent the difference between the actual purchase price and the market price, for various trading volumes and markets. Positive values suggest that the transaction price is below the market price, favoring the buyer, and vice versa. We observe that in the investment-grade bond market, transactions below 50,000 tend to have significantly higher costs, exceeding 0.06, while in the high-yield bond market, these transaction costs can reach as high as $0.30.

Moreover, to delve deeper into the transaction costs of institutional investors and individual investors, we specifically compare the 144A market, exclusive to institutional investors, with the non-144A market, accessible to all investors. It becomes evident that institutional investors often secure more favorable purchase prices, particularly for transactions below $100,000. Consequently, billionaires with institutional-level assets also benefit from reduced transaction costs when acquiring assets.

Similar to the rationale behind transaction costs, billionaires, who are akin to institutional investors, often enjoy reduced management fees when investing in funds. According to research conducted by the Financial Conduct Authority (FCA) in the UK, institutional investors pay a mere 0.23% in management fees for actively managed funds, whereas retail investors are charged up to 0.69%, representing a threefold increase compared to institutional investors. This disparity can be attributed to the limited negotiating power of intermediaries handling retail funds when compared to institutional investors.

Sean Hagerty, the head of Vanguard Europe, emphasizes, "as a fund's size increases, its fixed costs and management expenses should decrease as a proportion of asset size. Vanguard strives to pass these economies of scale back to our clients through lower fees. However, we notice that not all of our peers adopt the same approach." In essence, retail investors often do not fully capitalize on the advantages of economies of scale in fund management, as fund companies do not uniformly transfer the benefits of increased scale to retail clients, unlike their institutional counterparts.

Conclusion

Over the past two editions of Poseidon Market Foresight, we have examined the evolving trends of global billionaires since the start of the 21st century and revealed the distinctive features of their investment portfolios. If you happento be one of the elite 2,781 billionaires, we would be delighted to hear from you and gain your investment wisdom. For those who, though not billionaires, aspire to access the exclusive investment channels and fee advantages that the ultra-wealthy enjoy, stay tuned for our upcoming edition of Poseidon Market Foresight. In our forthcoming installment, we will share with you how to “invest like abillionaire,” guiding you to embark on a new journey of wealth preservation.