The Democratization of Private Capital Markets And How Non-Traditional Investments Are Finally Available for Retail Investors

What are private?markets?

Given risky assets and bond prices have plummeted due to soaring inflation and higher rates enduring one of the worst starts to the year on record since the Great Financial Crisis, here’s a refreshing guide to non-traditional investments and a whole new inflationary-proof world of investing that has become officially democratized for everyday investors to finally get a slice of the action.

Private markets are investments made in privately owned companies that may issue stock and have shareholders but are not publicly traded on an exchange or through the stock market.

There are several key factors that distinguish private from public markets that are most notable within the types of investments they offer and investors who have access to private market funds.

Private markets, also known as closed-end funds which exist under the umbrella term, private capital markets include investment funds within private equity (PE) and or private debt, private credit (PC), venture (VC), and growth capital (GC), and real assets such as real estate, infrastructure, commodities, farmland, and natural resources.

The key differences in investing in private versus public markets includes less liquid (illiquid) investments with a longer lock-up period, investors include institutions, accredited investors, and high income or net-worth individuals with a longer investment time horizon versus short-term retail investors, negatively correlated non-traditional investments to the public markets to offer potentially more diversification, more opportunity to take on leverage for potentially greater return, larger ownership and control specifically through a minority stake in a high- growth potential startup within VC, and inflationary proof investments offered such as through real estate or farmland.

Although funds available in private capital markets have unique advantages and opportunities to hedge against systematic risk compared to publicly traded investments, both present their own risks and challenges to the investor based on their risk tolerance.

Some examples of privately held companies that exist within the private capital markets today include companies such as Bloomberg, Deloitte, IKEA, hedge fund, Tiger Global, and high- promising growth startups such as Greenhouse.

Key?Access

Private market investments within the private capital market are known as closed-end funds that are not publicly traded or available on the stock exchange.

Private markets include a variety of funds known as non-traditional investments. These include VC, GC, PE, PC, and real assets such as real estate, commodities, and infrastructure.

The main differences between private vs. public markets include limited liquidity with a longer time horizon, investors include sophisticated, accredited investors and large entities including sovereign wealth funds, insurance companies, pension funds, endowments, and or high income or net-worth individuals who focus on long-term returns with a considerable investment lock-up period, and private markets are less regulated than public markets given the lack of retail investors, high barrier to entry, and non-public securities available.

Opportunities to invest in private capital market funds include negative correlation to the stock market to be able to find a ‘golden goose opportunity’, hedge or beat the market, extra diversification, potentially higher alpha, inflationary-proof, and investments not available to the general public.

Given the illiquid lock-up periods for example with farmland and PE, high management and performance fees paid to VC and PE, alongside the extra beta and minimum investment threshold, private markets are traditionally only open to accredited investors or qualified clients which include high income or net-worth individuals, institutional investors such as insurance companies, endowments, and funds (E&F), pension funds, and or sovereign wealth funds.

Retail + Accredited Investors

Since the start of 2022, public markets have been turbulent due to rampant inflation, and rising rates which have led to higher borrowing costs, Russia Ukraine war, the energy crisis, supply chain constraints, and slower economic growth that present challenges to publicly traded companies and investors alike.

Due to the heightened uncertainty after a roaring stock market since the pandemic’s turnaround in Q2 2020, accredited and institutional investors alike have turned to private markets to seek more diversification, non-correlated returns, and reduce market and cyclical risks from macro and micro-related developments during this unprecedented time. These investors are seeking refuge from volatility to safeguard their assets, beat the market, and tap into alternatives and non-traditional assets. Given the higher barrier to entry due to illiquidity, lock-up constraints, and more leverage available, private funds such as private equity or venture capital may present more opportunity in the long run, especially since unicorns’ road to going public has stalled this year due to rising rates and costs with the fear of a looming recession on the horizon.

Inside McKinsey’s Global Private Markets Review 2022, the global firm shares its in-depth analysis and view on the private markets compared to prior years for analysts to better understand the current market at play. They share their findings on private market funding pools from each private market fund including from real assets such as real estate, infrastructure, and natural resources alongside private debt and private equity.

Today, there is new research on retail investors’ growing interest and presence in private capital markets. Since the pandemic began, many new platforms such as Fundrise and Crowdstreet have democratized investing in farmland and real estate developments for as little as a few hundred dollars. Compared to the traditionally hefty minimum threshold required to invest in private markets which were mainly open only to accredited and institutional investors as noted above, this a unique finding McKinsey has reported on stating:

“Retail investors, representing a pool of over $50 trillion, are a second large source of capital with growing interest in private markets. Allocations today remain in the low single digits, principally due to historical access constraints, but a combination of changing regulations, product innovation, and new GP distribution capabilities is bending the penetration curve. A recent survey4 found that over a third of private markets managers anticipated having a retail-oriented vehicle in the next five years; just 9 percent have one today.” (10)

Recap

Over the decades, there’s been a considerable rise of funds poured into private markets as it's seen as an attractive non-traditional alternative to public markets securities as a long-term commitment for growing returns in a more diversified way. Although every market comes with potential risks and downsides, private market capital activities present unique opportunities for a highly sophisticated and younger retail investor base looking to take advantage of opportunities outside of the traditional public markets.