How much do you know about private markets?

Private investors are increasingly turning to private markets because they offer the potential for higher returns compared to public markets, coupled with diversification benefits and a lower volatility than stocks. In addition, they offer access to innovative sectors and exciting themes.

However, most end investors and even many financial advisers do not yet know in detail what private markets and their constituents are, partly because most of the information available is written for professionals in a very technical language.

This newsletter aims to bridge this knowledge gap and help you develop a solid understanding.

What does it mean to invest in Private Markets?

To start with the basics, Private investments are assets or financial instruments that are not listed on a public exchange. The purchase transactions are negotiated in a private agreement under the exclusion of the public. In contrast, stocks and bonds are regulated securities traded on a public exchange with a public price. Everyone can decide to buy or sell them.

Private market firms typically take an active role in the decision-making process of the assets they invest in; that’s a main difference from public markets, where investors remain rather passive.

Private equity firms and their fund managers can act as consultants, advisors, or even CEOs to a company beyond just sourcing capital. They can play a key role in shaping a company’s strategy, helping it grow or transform, and creating value from within.

What are the main 4 categories of private markets?

Private markets are mainly consisting of these 4 categories:

1.???? Private equity (PE) strategies refer to equity investments in companies that are not publicly traded, which provide investors with equity-like ownership interest and returns. PE can be further divided into sub-strategies, depending on the stage in the life cycle of the target company, the size and the financial situation. Technically it means investing in private companies or buying out public companies to make them private.

In practice, Private Equity firms get deeply involved in building and growing the companies they invest in. They have their own specialists and industry experts in many areas and act as partners and consultants to their investments, unlike stock owners, who are typically fairly passive investors. ?

Their goal is to improve the company’s operations and financial performance and eventually sell it at a profit. Private equity offers the potential for high returns and the ability to influence the company's direction.

2.???? Private debt refers to loans made to companies that are not traded on public exchanges. These loans are typically used for business expansion, acquisitions, or refinancing existing debt. Private debt often goes hand in hand with private equity; both counterparties negotiate the terms for private debt with a joint interest to find a healthy solution for the borrowing firm. The benefits of private debt include regular income through interest payments and a higher yield compared to traditional fixed-income investments. Still, they can have other benefits like collateral, much higher recovery rates in the case of a default and floating rates.

3.???? Infrastructure investment involves directly investing in physical assets like roads, bridges, airports, hospitals, gas pipes, and utilities. There are also types of infrastructure required to reach the public goals for building out renewable energy, such as solar and wind parks or fiber optic cable networks to progress internet speed and quality. These investments provide essential services that drive economic growth. The benefits of infrastructure investment include stable cash flows, inflation protection, and low correlation with other asset classes.

4.???? Real Estate investing involves purchasing properties for rental income or capital appreciation. These properties can range from residential to commercial, such as office buildings and shopping centers. The benefits of real estate investing include the potential for high returns, regular income through rent, inflation protection, and diversification benefits.

New technologies like blockchain are making it increasingly possible to buy and own shares of artwork, patents and license rights for music and films. But so far, these represent only a minor share of the market, while private equity alone represents more than half of it.

Why is investing more challenging for private market firms?

Access to information about private market- target investments like companies and their financing needs, real estate or infrastructure is more challenging than in public markets.

For businesses and so-called real assets such as infrastructure or property listed at an exchange, obligatory reporting duties include financial statements, prospectuses, and semi-annual reports.

In contrast, a company owned by a non-public individual or consortium like the founder, his/her family, and probably another private market firm has no such duty to keep anyone informed. Private market investment firms rely on their own resources and network to find attractive investment opportunities and perform their due diligence. This due diligence and subsequent negotiations with the owners can take months or even years.

The better a manager is at getting information, determining an investment thesis, and finding and negotiating deals, the better they can spot and realize rewarding investment opportunities.

Why have private investors not invested earlier in private markets?

For most of the last three decades, while private markets enjoyed solid and ever-growing momentum, institutional investors like insurance companies, pension funds, and family offices have been the main advocates of private market investing. Private investors were limited to the public markets or direct investing in private assets.

One reason is that the mechanics of private market investments are more complex to explain and understand. Another is that the available fund structures were unsuitable for end investors due to high minimum investment amounts and long investment periods.

As private investments are traded publicly, there is generally less financial information readily available about them, and they are less liquid than a stock bought and sold on a major exchange, or a corporate bond that trades over the counter. The limited liquidity and transparency in private markets are two of the biggest differences from public markets and are factors an investor should be aware of before allocating to the asset class.

In recent years, new fund structures have been created by the regulators of the financial industry to give private investors access to private markets, too. From the perspective of the public interest, this has two benefits:

1.???? There any many public priorities which require investments at a large scale, more than possible just with the available public budgets. Examples are building out renewable energy facilities and telecom networks or repairing bridges and other key infrastructure.

2.???? The pension gap, due to the ageing of the population, requires higher returns for future pensioners in many countries to match their needs.

In conclusion, private market investing offers a wide range of opportunities for investors. However, it’s important also to understand the complexities and risks involved. This new educational series aims to cover both opportunities and risks.

The next editions will explain the four main categories in more detail, starting with private equity. Don’t miss future learning opportunities, subscribe to get a note when the next editions are released!

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