Private market investing: Diversifying beyond public markets

Investing insights

In 2004, venture capitalist Peter Theil invested $500,000 into a fledgling startup called Facebook. At the time of the company’s IPO, Theil’s stake was worth more than $1 billion.1

“Theil’s investment is an exceptional case, but private market investments have historically outperformed public equity markets,2” says Kaush Amin, managing director, private market investments at U.S. Bank Wealth Management

Private markets include funds investing in private equity, real estate, private debt, infrastructure, and natural resources. Private equity comprises most of the investments in private markets, such as financing start-up companies, providing growth capital for fast-growing businesses, and buying mature public or private companies.

While this type of investing isn’t available to everyone, you also don’t have to be a Silicon Valley bigwig to do it. “And because private market investment returns are not highly correlated with public markets, investors may receive portfolio diversification benefits,” says Amin.

Financial and timing requirements for private market investing

Qualified individual clients* interested in exploring private market investing should be aware of and comfortable with its unique aspects:

  • A limited time window, often two to six months, to decide whether to invest.
  • Typically committing to a total amount instead of immediately investing a sum of money.
  • Investing the total committed amount over a period of time.
  • The exact timing of the contributions varies, as does the total investment period.

“In the public markets, you buy stocks or bonds that have an explicit value, and the opportunity to invest remains perpetually open,” Amin explains. “In private markets, there’s a start and end date to raising funds that will be invested over time.”

Assess private market investing risks and financial obligations

Investing in private market funds carries risks that differ from those that come with investing in public markets.

  • Illiquidity. Investors who own stock in publicly traded companies can sell at essentially any time. “Private market fund investments are generally considered illiquid, with an average commitment of 7-12 years. Although a secondary market may exist for some funds, it’s not as active as public markets,” Amin says.
  • Harvesting. Private market investors only realize potential returns when the fund manager “harvests” gains, which may occur when a fund sells a business it’s financing or the company goes public. If private market investors want or need to sell before the fund harvests its gains, they may have to do so at a discount. The discounted amount depends on the demand for the fund and where it is in its investment or harvest period.
  • Binding commitments. Private market investors must also be prepared to meet the commitments they make. When a fund manager requests money, investors are legally obligated to provide it.
  • Fees. Funds typically charge both a management fee, which is a fixed percentage of the committed capital of the fund, and a performance fee, which is a share of the profits.

How to invest in private markets

Investors can access private markets by investing directly in private companies or by investing through commingled private market funds.

While Amin encourages all qualified investors to consider private market investments, he highlights the importance of manager selection. Investors committing to a private market fund are committing to a team of professionals. “There’s a very high dispersion of returns between the good fund managers and the not-so-good managers,” he explains.

Private market investments can play an important role in portfolio diversification and can offer attractive absolute and risk-adjusted returns over the long term. Investors should be careful, however, due to identified risks, and variations in private market manager experience. An experienced and diligent private markets team can help individual investors navigate the landscape and identify appropriate high-potential opportunities.

 

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*Qualified individual client must meet the accredited investor criteria , in the context of a natural person this includes anyone who: earned income that exceeded $200,000 (or $300,000 together with a spouse) in each of the prior two years, and reasonably expects the same for the current year, OR has a net worth over $1 million, either alone or together with a spouse (excluding the value of the person’s primary residence), or has a Series 7, 65 and/or 82 securities license(s).