The Private Investment Opportunity
Private investments continue to play a larger role in the investment universe. While investments in this market have traditionally been limited to ultra-high net worth individuals and institutions, changing regulations, as well as changing technology, are enabling smaller investors to access these investments for their portfolios.
How to View the Private Investment Universe
Overall, Kings Path has a positive view on private investments as they offer diversification benefits and enhanced return potential. But they generally come with complexity (e.g., long subscription documents, tax documents, liquidity restrictions) and can be difficult to understand. Unfortunately, too many investors expect private investments to be the key to their retirement and look for the “home run” that makes up for years of not saving or for making poor investment decisions. This is not a healthy way to view private investments. Others shy away from private investments because they think they are too risky, or the industry players seem too corrupt. While there are very risky investments and there certainly are some bad industry players (both of these also exist in public markets!), we caution against painting the industry with a broad brush.
A healthy approach is to view private investments much like institutional investors do – as a strategic part of a diversified asset allocation that is built and managed over time alongside public investments. In this short blog, I can’t cover everything about private investments, but let me provide some quick observations on private equity and private credit, two of the largest private investment markets.
Private Equity
Private Equity Market Overview
Private equity covers a VERY diverse set of strategies and there are many ways to invest. You can invest in individual businesses, or in funds that invest in a diverse set of businesses, or even in funds that invest in other funds. You can invest in a range of strategies such as buy-out, growth, and venture. You can focus on particular industries, geographies, or the size of deals. There are many approaches each with different risk parameters and terms. Some “factoids” on private equity to consider:
Historically, private equity returns have exceeded public market returns and have had less volatile returns. This “excess return” generally comes with more risk and less liquidity.
Private equity often allows for more control over a company’s operations, which is one theory for the excess return.
Private equity has tended to provided diversification benefits to public equities (that is, returns are not perfectly correlated).
Private equity leans more toward younger, growth-oriented companies than older public companies.
The universe of publicly traded companies is shrinking, and the universe of private companies is growing (see Figure 1).
Companies are staying private longer and going public at higher valuations, so private investors capture the growth that public investors used to enjoy.
There is a wider dispersion of performance results from managers and picking and accessing top managers is critical.
A Growing Market
There is over $4 trillion invested in private equity managed by over 11,000 private equity firms globally (see the study by McKinsey, linked below). While the private market is smaller than the public market in size, privately funded companies are obviously a key part of the overall economy and are worth considering a part of one’s portfolio.
Two good industry overviews are:
McKinsey’s Private Markets Annual Review
Bain & Company Global Private Equity Report 2021
And our blog on private equity from June 2018 is still appropriate: Private Equity: A World of Opportunity?
Private Credit
Another Growing Market
Private credit continues to be a growing industry. Basically, this is non-bank, non-public lending to businesses and other institutions. This industry has been growing at a high rate over the last decade for several reasons including:
Banking regulations have pushed banks away from certain lending.
Many loans are of short-term nature and banks are slower to respond and less enthusiastic than private lending institutions/funds.
There is an increasing universe of private companies, and companies are staying private longer. Borrowing is a key part of their capital structure.
Companies are wanting uniquely structured loans and terms – something public markets or traditional banks cannot accommodate.
Direct lending companies and funds have raised significant dollars to meet this growing demand. Today, almost $1 trillion is invested in private credit. While this pales to the size of the public credit markets, this is still a very large, and growing number. Like the breadth of opportunities in private equity, there is also a range of direct lending investment options that can be tailored to investor portfolios. Direct lending companies and funds can focus on geography, deal size, industry, loan terms. And risk can be modulated by the terms of loans with collateral, penalties, rate changes, covenants. It is important to know the risks with any fund investment. Investors not familiar with this space are often skeptical or think of this as a risky, junk bond play. While high-risk loans exist, many of the lenders insist on having access to collateral and covenants.
Benefits of Private Credit
Direct lending has provided investors many benefits (past performance is not a guarantee of future performance):
Historically higher yields and returns than comparable risk public debt (see Figure 2 below).
Diversification from traditional fixed income (actually, negatively correlated over last 15 years).
Interest rate protection, as many are variable rate loans.
Lower default rates versus comparable risk public debt.
Good industry overviews can be found here:
Private Credit: The $1 Trillion “New 40” Opportunity
Blackstone’s “Why Private Credit”
Private investing can be complex and should be considered carefully. They are not right for all investors. Many investments are only open to certain investors such as “Accredited Investors” and “Qualified Purchasers” as defined by the Securities and Exchange Commission.
