Private equity has been an area dominated by institutional investors and wealthy individuals for many years.
There are new trends appearing that are making investments in this asset class more prominent and creating a stronger argument for including it in portfolios for all types of investors.
The number of U.S. publicly owned companies has been declining for many years. Fewer companies are going public, and those that are listed are using debt to finance share buybacks at unprecedented levels.
The Path Has Been Quite Different For Private Assets
in 1980 to more than 10,000 today From 1980 to today, the number of US companies going private or staying in private hands has increased from 1,500 to 10,000. This number has increased from 18 years ago to today. There are now 7,500 private companies, which is 3,200 more than the number of public companies in the United States.
Private investment firms are a small part of the global market, but they are becoming increasingly important in providing money for companies of all sizes in different industries.
Private investors in the past have been known to invest in businesses that are not growing and have a lot of assets, but are being sold at a low price. Now, there are more opportunities to invest in companies at different stages, including high-growth technology firms.
A large portion of the growing private equity market is due to the reduced role of banks. Banks are being restrained by regulation and technology after the financial crisis.
Many high-quality borrowers are unable to secure bank loans due to new underwriting standards. As a result, direct (non-bank) mortgage lending is growing. Private equity firms are arranging private debt to fill out the capital structure of banks.
The rise of new lending platforms is largely due to private equity firms who are providing the funding for these businesses to grow. This is causing a disruption in the banking industry as these new platforms begin to compete with traditional banks.
Traditional Appeal And Advantages
This suggests that private equity is becoming more important and central to portfolios than it was in the past. An asset class expanding does not mean it should be included in every investor’s portfolio.
Asset class is more appealing than private equity, as it has a history of outperforming traditional assets over time while providing valuable diversification.
Private equity has outperformed public equity and adding private equity to a portfolio tends to enhance returns and reduce risk.
What’s behind these outcomes? In our view, they are driven by several key advantages inherent to private equity investments:
Information And Control
Private equity managers have more control over the information they have access to and the governance of their companies, which allows them to make improvements that increase the value of their company.
Timing
Private equity managers often take months to find and complete investments, and can choose between selling to other private equity funds, trade sales, and IPOs when they exit.
Hedge funds offer investors more flexible timing for both entering and exiting positions, which can be an advantage over investing in the public markets.
Distinct Opportunities
Private companies are much different than larger firms who can take public ownership demands and turn it into success.
A company that is in a changing industry or early in its growth cycle will have a more difficult time in the public markets, where investors are increasingly demanding consistent, linear growth in earnings.
There are many private companies that do not have public investments that are equivalent. They may be small divisions of larger companies that are hidden from view in public settings, or their value may be apparent more readily as private holdings.
Fitting Private Equity Into A Portfolio
The time horizon, lockup, and different nature of opportunities have tended to create opportunities with impressive returns and a lower correlation to more traditional investments.
Even though there are advantages to investing in private equity, most portfolio managers only allocate 10% of the portfolio to this area.
Additionally, it is essential to take into account the investor eligibility requirements, risks and nature of private equity when determining whether it is a good fit for your portfolio.
There are many things to think about when investigating private equity. First, there is illiquidity. It can take private equity investors time to find appropriate investments and to come up with and carry out an investment thesis.
While public markets allow investors to regularly buy and sell their holdings, traditional private equity typically has lockup periods that can last for years. The growth of the secondary market in private equity is making the asset class more liquid, making it easier to sell before lockups expire.
The J-curve is where investments don’t all occur at once, but rather cash is called from investors as the manager sees fit and time is needed for investments to create returns.
This means that the private equity funds can lose money in the early years. If the investments are successful, they will be worth more and the fund will make money.
The high investment minimums may make it difficult for investors to commit to the asset class, and they may not be able to provide for vintage year diversification.
Private equity firms are now offering investment strategies with lower minimum requirements, making it possible for more individuals to invest. However, the requirements are still relatively high.
Other Considerations
If you’re wondering if now is a good time to invest in private equity given the current market conditions, you’re not alone.
private equity unique qualities: the opportunity for operational/financial improvements and strategic changes facilitated by the private owner’s controlling interest, a typically long-term approach, and often specialized experience that can provide competitive advantages.
Keeping some public equity exposure is sensible, and having a strategic private equity weighting may also be a good idea.
Public And Private Exposures Working Together
We keep hammering the total-portfolio theme for many reasons. First, it’s important to focus on the main goals of the portfolio, the core investments that are targeted, and the risks that cannot be taken.
It can result in seemingly contradictory outcomes: Anchoring on a specific time horizon can often result in very different private markets portfolios for different institutional investors. This can cause seemingly contradictory outcomes. It is important to keep in mind what your goals are so that you can target private market strategies that align with your overall goal, such as return, income, or a certain liquidity profile.
We can better construct the portfolio once we have the blueprint for the whole thing. We believe that better skills and more opportunity for active risk-taking generally leads to better performance.
This is especially true for private markets, where investors may want to focus on certain asset types or sectors even in a more diversified portfolio.
An example of this would be at Russell Investments, where I don’t want the private markets team to feel restricted by worrying about overexposure to a particular sector or having to meet a long-term target in any given year.
I want them finding the best return opportunities. I understand that private markets opportunities are more complex and less flexible. I need the publicly-traded part of my portfolio to be adjustable so that I can keep my overall portfolio exposure and diversity. An equal and opposite lever in public markets is necessary for private markets exposure to work well as a return lever.
Most Investors Need To Manage Their Private Markets Exposure Dynamically
I’m saying that you should build your investment portfolio with multiple types of investments so you can take advantage of market opportunities as they come up, and that you should adjust your portfolio periodically as your goals change and the markets change.
Secondaries As A Source Of Eeturns
A vintage year is a stronger indication of risk for wines than for other assets, and it is crucial to have strong performance from different vintages to achieve solid overall results Private investors believe that it is important to invest in a variety of different vintage years. Vintage year is a stronger indication of risk for wines than for other assets, so it is important to have strong performance from different vintages to achieve solid overall results. Private equity investing generally involves larger investments in fewer companies, as opposed to investing in only stocks and shares.
This means that you cannot buy what was bought last year, so the set of opportunities available changes each year. An investor who relies too much on that approach may not be able to allocate funds to private markets for years. And nearly all investors need the returns now.
Secondaries can help. A secondary is a private asset that is being sold while it is still being invested in.
If you’re just starting a private investment program, it can be helpful to use secondary investments as your primary source of income. This way you can get money into the ground quicker, while still maintaining a diverse portfolio.
The purpose of this activity can be either to advance a company’s strategic objectives or to mitigate potential risks. If investors have the right level of access and skill to identify attractive pools of secondary assets, they may be able to build a portfolio of PMs more quickly and with less risk.
As new vintage years are added, the allocation to secondaries may be reduced, but it can still remain an attractive return source.
The Importance Of A Dynamic Approach
Additionally, the investments in the private portfolio will change over time, based on new investments and the speed at which existing investments are cashed in. A holistic and dynamic portfolio management approach is important because it takes into account all aspects of a portfolio and how they interact with each other.
Best-in-class asset managers take a multidimensional approach to diversification, rather than just focusing on public or private investing. By considering factors such as vintage year, geography, and manager skillsets, they can generate higher returns while creating greater diversity in the overall portfolio.
This means that the private-market portion of the portfolio can be used to offset risk in the publicly traded portion.
Dynamic management of a portfolio can help ensure that both the public and private investments are complementary.
When people think of portfolios as simply a compilation of different assets, they often fail to see the importance of managing risk across the entire portfolio. This can have critical consequences.
Consideration of private markets can diversify an investment portfolio. They can also help provide resilience during market downturns. Reducing behavioral investment mistakes may be helped by longer time horizons as investors are required to take a longer-term approach.
The Right Partner Matters
Private market investing can be both beneficial and harmful. We believe there are five key reasons that show why it’s vital for institutional investors to work with the right strategic partners:
A Total-Portfolio Approach
Big surprise, right? But, if you only do one thing on this list, make sure your strategic partner has both the depth of platform you expect from a private markets specialist and a total-portfolio approach.
There are more opportunities than ever before to invest in private companies. While this may mean more opportunities for customization, it also means more complexity.
Find a partner that can help you build a diverse portfolio, including both private and public investments, and who can help you manage these investments over time.
Access And Sourcing
Private markets outperform when accessed by top-quartile managers. How much does this access matter? According to Cambridge Associates, the performance difference between the best and worst managers is 14%.
The variety of funds available is large and complex. According to Hamilton Lane, 20 years ago there were 1,551 private markets funds. As of November 2020, there are 11,769 private markets funds.2 This means that there is a lot of interest in private markets and that they are attracting a lot of investment.
Portfolio Contracting & Administration
Investing in private markets requires literal limited partnerships. The fact that they are starting a business triggers a number of legal requirements, such as partnership agreements, private placement memoranda, and subscription agreements.
Each investment contract requires a thorough legal review and side letters that address issues such as key-man clauses, fees, terms, and other complex issues. Investors need to be able to negotiate these letters in order to complete the investment.
There are still likely to be numerous partnership amendments even after these partnership documents are signed and executed.
Many investors find the legal process surrounding investments to be very complicated and time-consuming. It is important for these investors to find a company that specializes in this area and has the resources to Dedicated legal resources.
This means that private-market investing requires constant data monitoring and engagement. An event like a capital call, when an investor is asked to provide more money that they originally committed to a fund, can start a chain reaction of complex activities.
Successful PMs continuously adapt their investment thesis and process to changing market conditions Given that each investment is unique, it is also more difficult to benchmark the performance of a portfolio manager.
A successful portfolio manager continuously adapts their investment thesis and process to changing market conditions. Proper monitoring of private equity firms includes engagement activities such as attending mandatory annual meetings and Limited Partner Advisor Committees (LPACs).
Risk Management
Private markets have seen an increase in market capitalization over the past ten years, with more opportunities to invest through primaries, secondaries, and co-investments.
With recent developments and better data access, investors can now get a clearer idea of how both public and private market risks work together across their entire portfolios.
This means creating a profile of how much cash flow different types of investments will generate, mapping out how different economic conditions will affect those investments, and combining all the investments in the portfolio to determine what positions should be taken with future commitments.
This means that investors with experience in the private market and a portfolio of legacy assets that are no longer active but still need to be accounted for in the total portfolio.
Operational Due Diligence
We believe that private market managers should have a separate operation team that performs due diligence on potential private market managers. This team would be outside of the investing function and would be able to provide the best possible solution for the manager.
This research will examine a company’s valuation policies and how they are structured, as well as look into the company’s reputation. Why? This type of effort can help private-markets investors by giving them another way to manage risks related to their reputation.
0 comments