By Natalie Morehead, Jun 19, 2024
Have you ever wondered if there may be investments outside of traditional markets that could help grow your investment portfolio? The secret may lie in private equity investments. If you own well-known investments like stocks, mutual funds, or ETFs, you’re most likely invested in the public markets. These types of investments are some of the most common, with the issuing company listing their investment on a public exchange so that the public can buy and sell as they please.
A much lesser-known option is to invest directly in the private markets. These opportunities have typically been less accessible to the everyday investor, but that landscape has been rapidly shifting, with many pathways recently opening with the rise of private equity investment platforms geared directly towards retail investors. Why would you invest in private equity vs a public investment? There are many compelling reasons that we’ll break down throughout this article.
The traditional lifecycle of a new company begins with a group of founding members bringing a new product or service to market by first proving initial proof of concept, next creating a minimum viable product, and then, selling it to customers. We all know these types of “start up” companies, often aiming to innovate an existing industry with something better or more compelling. These companies might seek funding from various seed investors, venture capitalists, and private equity firms, depending on their stage and what can be demonstrated in sales and future growth outlook. Note that institutional private equity firms generally invest in and manage early to mid stage portfolio companies to enhance their performance and generate returns. At this early stage, receiving funding and attention from private investors and new customers is extremely competitive, hence the term “grow or die”. This makes it imperative to innovate quickly, making decisions more quickly and decisively than would typically happen at a large organization.
Eventually, as a company grows to a specific stage it might seek funding from the public, which is when it will file for an Initial Public Offering (IPO). The IPO will list on a public exchange at a pre-set opening price, which is when the public can buy it directly in exchange for ownership shares in the company. Over time, these companies can eventually grow into some of the behemoths we know today – think about Apple, Amazon, Nvidia and Microsoft. They once started from these fledgling beginnings; we’ve all heard the once-upon-a-time stories about these people sparking brilliant ideas from their garage.
But what if you could buy a company before it IPOs? When the innovation is happening at exponential levels, and before it has reached the public? Could getting in that early provide that much more upside potential? History says yes.
According to Cambridge Associates their US Venture Capital Index, representing mid-to-late-stage private companies, has shown net returns of 28.45% over a 25-year time frame as of third quarter 2023. This is in comparison to a global public equity index such as the MSCI World/All World Country Index which returned 7.09%, or the Russell 2000, representing small-cap US equity, which returned 8.10% over the same time frame. That is an increase of 21.36% and 20.35% annual returns, respectively, demonstrating the long-term potential for more rapid wealth accumulation through diversified exposure. Although past performance can never be guaranteed and there is always risk present when investing, this data presents a case for the potential private company investing can have – higher returns compared to public markets.
In today’s market, modern companies are staying private for much longer than they used to. The median age for tech companies going public in 2000 was 5 years, compared with 15 years in 2022, according to Professor Jay Ritter at the University of Florida. The returns generated by these companies during their growth phase are typically only achievable by accessing the private market. As an investor, it can be advantageous to gain an earlier entry point to these companies by investing in private company shares. Historically private equity investors, including institutional funds, used various strategies to gain early entry into high-growth companies. They are aware that much of the early-phase, rapid, and highly valuable growth is shifting to the private market – where early investment creates opportunity.
Institutions worldwide are increasingly turning their attention to the private markets. According to Bain & Company, as of 2023 “fewer than 15% of companies with revenue over $100 million are public,” giving public investors narrow exposure to the broader economy. So why should retail investors only get access to this narrow slice of the market? Traditional private equity funds typically have high minimum investment requirements and strict eligibility criteria, making them accessible primarily to institutions and the ultra-wealthy. Additionally, Bain & Company reports that “wealthy individuals (not to mention their advisers) are increasingly drawn to alternative investments as they look for new diversification options and better returns than they can get in the traditional markets for public equity and debt.” To address this investment gap, much attention has been recently given to this asset class traditionally only available to institutions and the ultra-wealthy, with many new platforms arising to fill the need to make private equity funds more accessible to accredited investors and other retail investors.
Gain Private Market Access
In the world of investing, it’s important to understand where you fall on the “risk/return” spectrum. Meaning, how much risk are you personally willing to take in order to get the returns needed to reach your goals? Basic investing principals state that achieving higher returns requires taking more risk. Each type of investment has its own “risk/return” profile that can be charted across a spectrum. Equities typically have higher return potential, albeit more chance of downside and volatility, while safer investments like bonds will provide lower returns, but less chance of losing money. As one nears retirement age, it’s common to decrease your risk/return profile given you’ll need the money sooner therefore want to take chances of loss off the table. Experts have charted averages across the risk/return spectrum to provide a baseline of whether you’re taking the appropriate amount of return for the appropriate amount of risk. This is known as the “Efficient Frontier” and the chart goes up and to the right. When you think about it, it’s common sense – no one is willing to take high amounts of risk for a small payoff. According to Investopedia, “portfolios that lie below the efficient frontier are sub-optimal because they do not provide enough return for the level of risk.”
So, what can you do to get more potential return, without taking exponentially more risk? Research shows that by allocating a percentage of your overall investment portfolio to private equity you can increase return, while decreasing risk. How could this be? Does this defy common investment laws?
Well, private equity is somewhat non-correlated to public markets, meaning its price on average does not move exactly in tandem with public markets. Because of this, adding it to your portfolio can make it MORE efficient. When one asset goes down, the other might go up, or go down less, maintaining balance and helping weather volatility. As you can see in the chart below, adding even just a small allocation to your diversified portfolio of stocks and bonds may not only add return, but it can lower risk at the same time. Adding non-correlated other asset classes such as alternatives and private equity to long term portfolios is a strategy that is utilized by experienced financial professionals managing retail portfolios, as it contributes to diversification and risk mitigation. One must also account for the risks associated with private equity, including less liquidity and transparency in underlying financials, which is why diversification within the asset class is encouraged.
To explain the reason adding private equity to a portfolio helps improve your risk/return profile, we look to a study conducted by Neuberger Berman’s Private Equity and Institutional Solutions Team. They analyzed historical private equity market performance during the three most recent periods of market distress, studying the major economic downturns of the early 2000s, the 2007 – 09 global financial crisis, and the 2020 COVID-related market events. The study found that “private equity historically experienced a less significant drawdown, and a quicker recovery, than public equities in all three cases.” They also noted that “historically, private equity portfolios have generally experienced shallower peak-to-trough declines than the public markets….we believe private equity broadly is positioned to weather the storm and take advantage of opportunities that arise.”
Ahah, so that is why the addition of private equity can help a portfolio sustain returns over the long-term – because in theory, it has less ground to make up after losing value during periods of economic downturns.
In summary, investing in private equity can not only provide access to an asset class that captures early value from innovation and growth, it can help optimize a diversified portfolio throughout different market cycles. Institutions and the ultra-wealthy have been accessing this market for a long time, but in today’s day and age, there are pathways opening up for the everyday retail investor. Historically, a private equity fund or institution works with their Management Team to optimize their investment portfolios utilizing asset classes outside of the public market. Thankfully, there are now options for individual investors to access such investments by investing directly in private companies. The beauty of this is that you’ve hopefully gained another tool in your belt to help fine tune your portfolio, getting you that much closer to your goals.
This material, provided by Linqto, is for informational purposes only and is not intended as investment advice or any form of professional guidance. Before making any investment decision, especially in the dynamic field of private markets, it is recommended that you seek advice from professional advisors. The information contained herein does not imply endorsement of any third parties or investment opportunities mentioned. Our market views and investment insights are subject to change and may not always reflect the most current developments. No assumption should be made regarding the profitability of any securities, sectors, or markets discussed. Past performance is not indicative of future results, and investing in private markets involves unique risks, including the potential for loss. Historical and hypothetical performance figures are provided to illustrate possible market behaviors and should not be relied upon as predictions of future performance.
Natalie is Linqto's Head of Integrated Marketing, overseeing integration of brand content and strategy across various channels including social media, PR, and SEO. With 16+ years in Financial Services, she contributes a wide range of experience with a background in marketing, advisory, and regulatory compliance, previously holding Series 7 & 65 licenses. Directly prior to Linqto, Natalie played a key role in scaling a B2C Fintech from Series B to acquisition and launching a new consumer brand. She holds a BA in Psychology from the University of Colorado Boulder and an MS in Integrated Marketing Communications from Northwestern University.
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