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IN APRIL 2005, art dealers Robert Simon and Alex Parish traveled to New Orleans to attend an auction. They were particularly interested in a work titled Salvator Mundi. The painting was in bad shape, having been neglected for years. But Simon and Parish ended up bidding on it and taking it home for $10,000.
After some restoration work, the pair succeeded in having it authenticated as a work of Leonardo da Vinci. Since then, the painting has changed hands a number of times, most recently for $450 million. In that last sale, it became the highest-dollar art transaction ever.
Prior to its sale back in 2005, the painting had been hanging in the Baton Rouge home of a fellow named Basil Hendry. His family put it up for sale when he died, having no idea that the dilapidated work was a da Vinci. If they’ve been following the news since, I imagine they aren’t too pleased.
For most people, these kinds of things aren’t everyday concerns. But it does highlight an issue which is worth our attention, and that’s the challenge posed by appearances. In the case of the Salvator Mundi, the painting ended up being worth much more than it initially appeared. But when it comes to our personal finances, there’s the opposite risk: that things often appear more valuable than they are.
That’s for a few reasons. For starters, there’s the marketing concept known as value-based pricing. The idea is that consumers generally associate value with price. In other words, if a product carries a higher price, we tend to interpret that as a signal of quality. Price serves as a shortcut of sorts in making consumer choices.
There’s a well-known story, in fact, about the eyeglass chain Warby Parker. The group that founded the company met while they were students at the Wharton School. The founders had determined that they could sell glasses profitably for just $45, but they figured they’d ask their marketing professor, Jagmohan Raju, for advice. After looking at the numbers, Raju didn’t disagree that they could make a profit at $49 but nonetheless suggested they price them at $99.
Why? Raju felt that consumers might worry about the quality of Warby Parker’s product if the price were too low. “There are many companies selling cheap eyeglasses. Anyone can go on the Internet and buy two pairs for $99. But there is a perception among customers that the quality is not as good.” So Warby Parker went with $99 and has been very successful.
In many cases, it’s a useful mental shortcut for consumers to associate price with value. But when it comes to investing, it can work against us. The late Jack Bogle, founder of the Vanguard Group, summed it up best: “In investing, you get what you don’t pay for.” Price, in other words, is not a good signal of value. According to the data, it’s the opposite. Higher-priced investments have delivered worse performance, not better.
Investors know this, but still, it’s a challenge to sidestep high-priced funds. Why is that?
Author William Bernstein quotes the economist John Kenneth Galbraith, who wryly commented, “The world of finance hails the invention of the wheel over and over again, often in a slightly more unstable version.”
Wall Street, in other words, is very good at marketing. As consumers, we know what to expect from high-priced investments, but the industry is always finding new ways to convince us it can somehow defy the odds.
Which of Wall Street’s “innovations” should concern us most today? In my view, it’s a category known as private equity.
Private equity refers to investments in businesses that aren’t publicly traded. The pitch here is simple: Due to the growth of big tech companies such as Apple, Google and Nvidia, public markets have become very top-heavy. Today, more than 40% of the S&P 500 is riding on just 10 stocks. Historically, this has been much lower—between 20% and 30%. To detractors, this concentration means that public markets carry significant risk. For that reason, they see private equity, which is less top-heavy, as a good alternative.
Promoters of private equity also point to the fact that the number of public companies has fallen in recent years. For a variety of reasons, more companies are choosing to stay private. As a result, public markets are narrower than they were in the past.
I don’t deny either of these points. The question, though, is whether private equity is necessarily the right answer. In my view, there are quite a few other, simpler and better alternatives. There are mid- and small-cap funds, value funds and international funds—all of which allow investors to diversify beyond the big-tech exposure in the S&P 500 without venturing into private equity.
Why don’t I recommend private equity? I see five potential issues.
First, the government requires far less regulatory oversight of private funds. In contrast, especially with big mutual funds and exchange-traded funds, there is daily visibility into their holdings. That leaves much less room for mischief.
Private funds are almost universally more expensive than simple, publicly-traded index funds. Worse yet, because of the labyrinthine nature of some funds, it can be difficult to even know what the fees are.
Private funds also tend to be less diversified. That’s because the process of investing in private companies is complicated, requiring due diligence, negotiations and extensive documentation. All of this is time-consuming and expensive, so private fund managers don’t have time to make a large number of investments. Thus, these funds end up not being very diversified.
Private funds like to hold themselves out as being lower risk because the share prices of private companies don’t bounce around as much as the stock prices of public companies. That’s a clever argument but a little disingenuous. Unlike publicly-traded mutual funds, which are priced every day—and exchange-traded funds, which are priced throughout the day—private funds are often priced only on a quarterly basis. So their prices only appear less volatile. But that doesn’t mean they’re actually less risky.
The final concern with private funds stems from a combination of illiquidity and complexity. This year, a number of universities have had budgetary issues, and as a result, they’ve been scrambling to raise cash. Schools are big holders of private funds, but selling them hasn’t been easy. Because these funds aren’t tradeable on stock exchanges, the only offramp is through what’s known as the “secondary” market, where transparency is more limited. This added complexity doesn’t necessarily make these funds more risky—but it does make it much harder for investors to distinguish between a da Vinci and something that might just look like one.
Adam M. Grossman is the founder of Mayport, a fixed-fee wealth management firm. Sign up for Adam’s Daily Ideas email, follow him on X @AdamMGrossman and check out his earlier articles.
