The 60:40 Conundrum
The 60:40 approach (60% equities and 40% bonds) has traditionally been an effective way to diversify, as equities and bonds tend to offset each other when one of them declines. In 2022, both lost value, as a result of the sharp increase in interest rates and a troubled global economic situation.[1]
While the strategy has shown better performance since then[2], the equity-bond correlation could once again turn positive if inflation returns, interest rates go up, or market volatility increases, none of which are inconceivable in the coming year.
From “Cheap Beta” to Value-Added Strategies
In addition to being effective, the 60:40 strategy was relatively cheap to implement. The rise of index-tracking made stock-picking a passive exercise in following the markets (known as “Beta” in investing parlance). However, equity valuations are already very high according to most estimations, suggesting that a correction is due. Or at the very least, further years of bumper growth (>20%) are unlikely.[3]
Investors are therefore in need and in search of ways to ensure growth without exposure to the risks outlined above. As we have written about in previous articles, private markets (equity, credit, infrastructure) are less exposed to the volatility of publicly traded stocks and bonds, and also offer the potential for ‘hands-on’ improvement (value-added strategies) via operational or strategic change.
Late-Stage LBOs: A Differentiator in Private Markets
At The Family Office, we specialize in late-stage leveraged buyouts (LBOs). This involves identifying mature, established companies with stable cashflows, and finding ways to unlock additional value by working with the management team.
This could be described as the purest form of ‘active’ investing: not only choosing appropriate companies in which to invest, but helping to realize their potential for higher growth. This stands in contrast to passive investing, which can only watch the market and follow its twists and turns.
Balancing Illiquidity with Opportunity
In addition to the effort required in locating opportunities and finding ways to enhance growth prospects, private investments also have certain restrictions in comparison with public investments, chiefly, liquidity.
In exchange for the potential for higher returns, investors must be prepared to ‘lock up’ their money for longer periods, as value-added strategies often take years to implement and for business improvements to materialize. This is not necessarily a problem for those with longer-term time horizons, but is an important consideration for those with near-term liquidity needs. Although these strategies are designed to capture long-term growth, they are not entirely immune to market fluctuations and operational challenges. Our active management approach is focused on mitigating these risks while capitalizing on the opportunities presented.
Why This Matters for Investors
In addition to the need to diversify while enhancing returns, two important trends are leading investors to allocate more capital to private markets. The first is that fewer companies are choosing to go public, meaning that the universe of opportunities off publicly traded platforms is even larger than before.[4]
The second trend is that technology is making private markets investing more accessible and transparent. Whereas previously many processes were done manually, new automated workflows mean that - for example - issuing and transferring shares can be done almost as seamlessly as on public platforms. The development of trading infrastructure, including secondary markets, also means that investments are less illiquid, reducing the risk to investors.[5]
Conclusion & Next Steps
Approaches to investing that have worked well for the past two decades may, or may not, be reaching an inflection point this year. While every investment strategy inherently carries certain risks, including market volatility, liquidity constraints, and sector-specific challenges, diversification and active management remain essential. No one can predict the future, but we can and should prepare for a range of scenarios.
While private markets investing spans a wide range of potential avenues, from venture capital to real estate, we have chosen late-stage LBOs as they offer a combination of safety (from stable cash flows) and upside potential (via operational improvements). There are no one-size-fits-all solutions, and we encourage you to discuss with an advisor before proceeding.