In recent years, private markets have become increasingly attractive for investors. A case in point, McKinsey titled its 2018 global private markets review ‘The rise and rise of private markets’. Traditionally classed as difficult to access and not mainstream enough for conventional investors, they have taken on a prominent role and are now considered a key option for portfolio diversification and attractive long-term returns.
‘Private markets’ is generally an umbrella term for a variety of investments that are not traded on a public exchange or market. What is grouped under this heading can vary, but it largely refers to private equity and venture capital, assets such as real estate, infrastructure and natural resources and to private debt. These assets are generally defined by their (more) illiquid nature.
However, secondary markets (such as Moonfare’s Secondary Windows, which enable investors to sell their investment after one year) can bring liquidity to private markets. One of the reasons that they have experienced such growth in recent years is due to the weakening of public markets, which has seen an increasing number of investors seek to tap into interesting growth opportunities beyond public equities.
Public market volatility has increased, while global growth is at least partially slowing. In the US, the number of public companies has shrunk, with statistics indicating that over the last 20 years their figure has roughly halved. As this has unfolded, the opportunities for investors have changed with it.
Public equity does not offer everything that a well-balanced portfolio requires, so to gain the best portfolio allocation, the net now needs to be cast wider. Cue private markets, who through their limited correlation to public markets and different investment strategies provide the necessary portfolio diversification. Investors can access private markets through various types of strategies. However, working with the right managers is crucial, as private market investments have high return dispersions and complexities that require expert know-how.
As a key private market investment option, private equity has different forms depending on the amount invested, the type of company invested in and the length of the investment. In this context, the terms private equity and venture capital are sometimes – and wrongly – used interchangeably. Both follow the same principles and refer to investments in private companies that are followed by an exit through selling that investment, for example by way of an IPO. However, there are differences.
While private equity firms primarily invest in mature companies with the aim of improving their revenues or financing growth, venture capital is all about investment in start-ups with high-growth potential. Private equity investments in a business are often majority shares or even complete ownership. In contrast, venture capital firms invest with lower shareholding rights, usually lesser than 50%. Another difference is that private equity investments have a lower holding period of between three to seven years, while with venture capital investments can take up to 10 years, as start-ups require more time to grow.
Lastly, while any kind of industry can be targeted by private equity, venture capital funds focus on the sectors that are typically associated with start-ups, such as technology or biotechnology. Between the smaller venture capital investments and the buy-out options of private equity to sits another type of private market investment: growth equity. Growth equity investments take the form of a minority share in companies that find themselves in between the start-up and mature company spectrum. This is also known as expansion capital, because funds are provided to finance expansion or otherwise transform or internationalise a business and generate growth.
As a form of private market investment, the growing importance of private debt is the result of another general market trend: private lenders filling the gap that has been left behind as banks have considerably been reducing their credit provision activities following 2008. Debt financing or investment essentially means that a company is selling debt instruments such as bonds to individual or institutional investors in order to raise money. Buying these bonds turns investors into lenders, who are paid back within an agreed period, in the same way to a bank that offers loans to businesses.
In the world of private markets, private debt is a very specialised sector that, given its often higher yields comes with analogous risks. A very sound and sophisticated evaluation of the borrower’s credit risk is therefore crucial. To get this expertise, some lenders specialise in specific industry sectors, as each type of company carries different risks.
Just like private debt, investment in physical assets such as real estate, precious metals, natural resources or infrastructure is on a growth curve. Some of the world’s biggest investment funds have created dedicated real asset departments. Real assets tick many of the same boxes as other private market investments, as they protect investors from market volatility and future inflation, being more stable than financial assets such as stocks. Data by asset management firms has shown that they are a dependable diversification tool that provide long-term value growth, and cash flow from real assets such as real estate can also be a steady income stream.