Mastering the Market with Private Investments

Imagine channelling your money not into the vast unknown of the market but directly into creating groundbreaking companies and funding world-altering inventions. This is the allure of private investments—in shares, property, and beyond.

In a financial landscape marked by constant change, private investments have emerged as a compelling opportunity for investors seeking attractive yields and portfolio diversification. Unlike the public markets, where businesses are up for sale to almost everyone, private investments offer a unique advantage: They are more diverse and hedge against market volatility. As investors turn to these non-traditional opportunities over public equities and bonds, it becomes important to familiarise ourselves with private investments.

We will delve into the basics and discuss the outperforming factors, risks and considerations, possible access ways, and future trends. Whether you are an experienced investor or a novice looking to expand your portfolio beyond common financial assets, this post will give you all the essential information regarding private investments.

What are private investments?

Private investments define funds in assets not traded in the public markets. These investments include equity, ownership stakes, debt, and real assets. They are often characterised by long-term horizons, relatively lower market liquidity, and potentially higher rates of returns than investing in public markets. In 2023 alone, private equity funds raised $785 billion.

• Private credit: A niche where non-bank lending is given to businesses, and more frequently, it presents flexible solutions that conventional banks cannot. It can be direct funding, subordinated, or distressed business loans. It topped $2.1 trillion globally last year.
• Private Equity (PE):
  A direct investment in the private firms or the leveraged buyout of a listed company to delist it. The total amount of capital raised by PE was $1.1 trillion.
  • Venture Capital (VC): VCs are a subset of PE focusing on early-stage companies with high growth potential. In 2023, $315 billion was invested in tech companies through VC, and the global investment market is projected to hit $1.3 trillion by 2032.
• Real assets: Real properties, including real estate, infrastructure, natural resources, and commodities, with value realisation capability in the real world. This essentialness affects the value of real assets, which has 8.2% IRRs in 20 years and closed its fundraising on $24.4 billion with 34 fund count.
• Hedge funds: Hedge funds are professionally managed pools of investors’ money in securities. They invest in all types of capital and asset classes, using various strategies to generate a high rate of return, such as gearing, futures, options, and short selling. As of 2023, 500 hedge funds were operating, and the value of assets under the management of hedge funds reached over $5 trillion.
• Private placements: The issuance and sale of stock shares or bonds to a limited number of investors and institutions without publicly opening on the market. It is an alternative to an initial public offering (IPO). The average size of funds is $188 million.

According to World Economic Forum (WEF) research, global private markets were $9.6 trillion in 2022 and distributed as shown in the graph below.

Graph source: https://www3.weforum.org/docs/WEF_Broadening_Access_to_Private_Markets_2023.pdf

Factors contributing to outperformance

In recent years, private investments have outperformed public markets by combining unique value creation, market inefficiencies, long-term focus, portfolio diversification and risk mitigation opportunities, and high minimum investments. In a global survey by Adams Street, 88% of respondents agree that private markets will continue to outperform public markets in the long run.

Value creation

Private investments have superior risk-adjusted returns than public equity and other traditional forms of investments. This is because of reasons such as operational improvements, where managers engage in operational adjustments aimed at improving the efficiency of portfolio companies; strategic acquisitions, in which managers seek to improve or add value to firms in the target portfolio; and financial restructuring, through which managers aim at changing the firms’ balance sheets to improve their values. According to a private and public investment comparison and their 10-year compound annual growth rate (CAGR) between 2012 and 2022, in four different categories (equity, credit, real estate, and infrastructure), the historical return of private is much more than public investments.

Graph source: https://www3.weforum.org/docs/WEF_Broadening_Access_to_Private_Markets_2023.pdf

If you invest $100 in 2001 and look at its value in Q4 2020 in five different sections (PE, S&P 500, MSCI World, fixed income, and hedge funds), PE will make your money as $775 with 11.5% growth while the next highest will be S&P 500 with $478 with 8.7% growth.

Market inefficiencies

Private markets contain some elements that may be absent or even less significant in public markets, which can create specific chances. Some of the inefficiencies and volatiles include the following reasons: less government interference in transactions, scarcity of information in the public domain, and usually complicated transactions. The inefficiencies result from differing perspectives of value by managers, investors, and molecules and time scales that are inconsequential to market prices for other agents.

The two types of markets are significantly different; private markets are less transparent, so there can be larger price differences and thus scope for arbitrage. However, despite its volatile market status, private equity has consistently outperformed by 4.2% of its public market equivalent since the start of the 21st century. By the end of the 2010s, the outperformance ratio was around 10%.

Image source: https://www.biteinvestments.com/resources/research-papers/why-investors-are-flocking-to-private-equity-in-search-of-consistently-higher-returns/

Long-term focus

Private investments are understood to have longer investment horizons. Thus, the investors’ and managers’ incentives align to create sustainable value. They argue that strategy change and improvements can be achieved without compromising with short-term market forces due to the long-term horizon of private equity firms. Such an approach is beneficial to aiding innovation, the enhancement of business operations, and the overall expansion of portfolio companies. That is because private equity firms have the luxury of a long-term perspective instead of the short-term imperialist goal of hitting quarterly earnings reports.

Image source: https://www.ifminvestors.com/siteassets/shared-media/news--insights-pdfs/ifm-investors_private-equity---buy-and-hold_mar-2022.pdf

Portfolio diversification and risk mitigation

Holding private investments can improve diversification and, therefore, reduce risk. Unlike publicly traded financial assets, private assets can have low correlation levels to the general market and, thus, can act as a hedge against possible market fluctuations and economic crises. This diversification benefit is also essential for institutional investors to enhance and improve their return targets and minimise risks. Investors can construct more sustainable portfolios through diversification and holding stocks across different sectors and industries, geographical locations, and classes of assets. According to the BCG, diverse private equity and venture capital firms grew at 25% annually, twice the growth rate of nondiverse firms.

Image source: https://www.bcg.com/publications/2024/diversity-in-private-investment

High minimum investments

The minimum investment amount for private markets can be between $250K and $500K. Such high minimum investment thresholds (which were still increasing by 25% in 2017) drive away some investors. However, they also impact outperforming private investments. High minimums appeal to wealthy, discerning investors who can afford to stick with the long-term results and risks inherent in such strategies. Since these investors tend to be motivated and have monetary resources and networks, they will likely make the private investment funds better than other investors.

Risk and considerations

Private investments offer many attractive returns and outperforming factors, but at the same time, there are some risks that investors must consider. In private markets, rates and inflation are thought of as the most significant challenges, but at the same time, there is a growing consensus that rates will be lower at the end of 2024. Other than timely challenges, there are five main risks that private investments come with:

• Private investments are complex, meaning that investors should be prepared to analyse the structure and terms and have a general understanding of the particular investment type. These factors might remain hidden from the outside world, and investors must be ready to face these issues to evaluate the appropriate value and risks surrounding the investment.
• Most private investments are characterised by a lack of marketability, so investors cannot easily convert them into cash. Money in business, particularly for investors, must be ready to be locked up for relatively long periods. It definitely raises the risk, especially in any financial crises or unanticipated capital demands.
• The minimum investment is relatively high (minimum average is around $250K-$500K), which may eliminate many investors. The rest must be willing to undertake the high risk that comes with the investment. Such risks may involve corporate, market, or operational risks that may negatively affect an investment decision. High-risk investments like venture capital can be risky since they can fold, which means the investor will lose the money.
• Private companies are legally exempt from releasing the same information as public companies, so investors must work with limited information. This may pose a challenge when comparing and analysing the various investment opportunities in private companies. In this kind of investment, investors must perform their research and rely on themselves and the track records of the fund managers or the sponsors.
• Evaluating private investments is difficult since they frequently lack market prices or trade rarely, enabling one to establish their true worth. Private investments use more sophisticated models that incorporate other assumptions and projections than public investments, which can be analysed using simple models involving the price-to-earnings ratio. Depending on the values and algorithms applied, this can result in relatively large deviations in the final numbers.

How can I access private investments?

Accessing private investments typically requires connections and resources. We have gathered the top three options for you to consider.

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Institutional investors

Institutional investors are legal entities that invest money on behalf of other people based on their interests and goals and allocate a portion of their portfolios to private investments. Due to their large holdings of stocks, bonds, or other security trades, these investors are considered the whales of Wall Street. There are several types of institutional investors:

• Banks
• Credit unions
• Pension funds
• Insurance companies
• Hedge funds
• Venture capital
• Mutual funds
• Real estate investors

Accredited Investors

Accredited investors are individuals or business entities eligible to invest in private placements not available in the public markets and may not be registered with financial authorities. The criteria to be an accredited investor include high net worth (over $1 million) or earning a certain amount of money per year (over $200,000).

What will the future be like?

The only thing that doesn't change is change itself. There are significant changes in the private investment markets, and you are lucky today because we know what the future will be like. Market transformation is driven by key trends, including sustainability, innovations, and regulatory changes. Check out the in-depth look for the sources of changes to what to expect.

The democratisation of private markets

For a long time, private investments have been the exclusive domain of big investors and the rich. However, with the democratisation of private markets, private investment is being opened up to the public, related parties, and even individual investors, regardless of their market status. This trend is supported by technological changes, product innovations, and regulatory changes. New fund structures like semi-liquid open-ended funds and closed-ended listed funds are being developed to offer greater liquidity and accessibility to private investors, enhancing their ability to participate in these markets. Some platforms enable smaller investors to engage in private equity and credit opportunities, while blockchain-based tokenization promises to reduce costs and increase liquidity. Additionally, regulatory initiatives such as the European Long-Term Investment Fund (ELTIF) and the UK's Long-Term Asset Fund (LTAF) create a more regulated and safer environment, making private assets more accessible to a broader range of investors.

Lower entrance barriers

Global entrance barriers have also continued to ease steadily as the private investment market has become more open in recent years. This shift is reflected in the rising proportion of funds introduced targeting wealthy individuals who might not have the scale of institutional capital but can invest more than traditional retail funds. Private assets are no longer as distant a dream as they were before. For example, a new generation of funds is designed for wealthy investors with ticket sizes of €10,000.

Lower interest rates

Although recent fluctuations and increased interest rates, market trends and insights show that interest rates will be lower by the end of 2024 with the decreased global inflation. According to the Navigating Private Markets in 2024 article, 88% of investors expect that fall. Lower interest rates often lower financing costs and benefit activities involving high leverage, such as private equity and real estate investment. They also make these investments more appealing than bonds and other traditional fixed-income instruments and may thus encourage more capital to be allocated to private markets.

Sustainability is here to demand

Socially responsible investments are only rising, making sustainable investments even more applicable to the young generation. According to the Natixis 2024 Private Assets Report, 44% of the institutions aim to maintain their environmental, social, and governance (ESG) investments by 2024, while 43% plan to invest even more. Moreover, 52% of wealth management companies have reported higher client interest in sustainable investment, which shows that potential investors are more and more inclined towards investment strategies that support their beliefs. Today, ESG represents a significant priority for investors and has become essential in the framework of modern private investments. It has been revealed that more than 60% of investors evaluate ESG as a significant factor influencing their investment decisions. Also, sustainable investments are the best source of private investment opportunities.

You are ready to master the market.

There is a lot of growth potential in fixed private investments for investors as an investment tool available in the market, more so when constructing their portfolio to realise higher returns. Some investment opportunities within these asset classes are private equity, private credit, real assets, hedge funds, and private placements, offering higher returns than the public markets even when benchmarked against normally “risk-adjusted” indexes. However, they come with some risks, high minimum investments, and low marketability, and this poses the need for potential investors to do some research to understand the risks attributed to the various markets.

It can be concluded that appreciable prospects of private investments appear as key drivers like the liberalization of private markets, reduction in the barriers to entry, and environmental concerns have become trends. The current forecasts indicate the likelihood of the interest rates coming down while the regulatory climates for private acquisition of goods and investment in private items are also anticipated to improve; therefore, consumption and investment in private items are likely to increase. Nonetheless, it is understandable that private investments bring a certain advantage for those willing to navigate these troubles and can be valuable when diversified within any investment strategy.