Diversification and private market investment: Looking beyond the public markets for returns

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 market investing is a broad label that encompasses any equity or debt securities of privately held companies, real estate and other real assets.

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

To participate in private market investing, an investor usually must meet “qualified purchaser” requirements, which include a minimum $5 million worth of investments.

The investor should also be comfortable with the unique aspects of private market investing:

  • Interested investors have a limited time window, often two to six months, to decide whether to invest.
  • Instead of immediately investing a sum of money, they typically make a commitment for a total amount.
  • Over the next two to five years, investors are called upon to pay the money they committed to the fund, eventually investing the total committed amount.
  • 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 risks and financial obligations

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

  • Liquidity. 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.
  • Financial requests. 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.

Investing in the appropriate private market funds

While Amin encourages all qualified investors to consider private market investments, he cautions it’s important to invest in appropriate funds. “There’s a very high dispersion of returns between the good fund managers and the not-so-good managers,” Amin explains. He and his colleagues follow a thorough process to understand potential risks before making a fund available to U.S. Bank Wealth Management clients.

The Wealth Management team at U.S. Bank builds relationships with a number of private market fund managers. In addition, they consider the opinions of strategists and economists who look at macroeconomic trends and factors affecting industries or sectors when selecting funds.

U.S. Bank also follows an investor-first perspective. “We do not charge any kind of placement fees or receive any fees from funds on the platform” Amin says. “We are presenting opportunities to investors that we believe to be the best fit for them.”

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