Key Takeaways
- Private market investments are investment opportunities that aren’t traded on public stock and bond exchanges.
- Common examples of private market investments include private equity, private credit, private real estate and private infrastructure.
- These alternative investments can be beneficial for UHNW investors and other qualified investors due to their potential for enhanced returns, portfolio diversification, downside protection and unique access.
- Key potential drawbacks include higher fees, more complexity, longer lock-up periods, illiquidity and higher risk than public markets.
- Integrating private market investing into your wealth plan can be beneficial, but it requires careful portfolio construction, planning and expertise.
A growing number of both institutional and individual investors have been flocking to private markets in recent years. Many are drawn to the lower correlation to public markets and enhanced return potential. However, that upside doesn’t come without costs. Private market investments generally involve more risk, limited liquidity and higher fees than traditional investments. Still, when strategically managed, they can play a valuable role in a well-structured wealth plan.
What Are Private Market Investments?
Private market investments refer to investment opportunities that aren’t traded on public stock and bond exchanges. Instead, investors put money into a private fund vehicle that invests in privately held companies or assets. These private investments tend to have lower correlation with public markets, which can help diversify your portfolio and reduce volatility. They also tend to be less liquid than public assets but, in return, can offer higher potential returns.
For UHNW investors and other accredited investors, private markets can be an attractive complement to traditional public market portfolios, offering diversification and potential return enhancement alongside core stock and bond holdings. Below are the key types of private market investment classes to know.
Private equity
Private equity (PE) is a type of private market investment that involves a private equity firm raising money from various sources, including ultra-high-net-worth individuals and institutional investors, and using the funds to buy ownership stakes in private companies. The firm then actively manages the portfolio companies and makes operational improvements. The goal is to increase the value of acquired companies over a period of around five to 10 years and sell them for a profit. Once a company sells, investors receive their distributions.
Private equity has demonstrated its potential to generate higher returns than traditional equity investments. For example, recent data highlights that, as of December 31, 2023, the Cambridge Associates US Private Equity Index delivered a 25-year average annual return of 13.1%, compared to the S&P 500 Index’s return of 8.6% over the same period.
Private credit and private debt
Private credit (also called private debt) refers to loans made outside of public markets to privately held companies, often in the middle market. The loans are issued by private credit funds that pool money from investors and negotiate customized terms directly with borrowers. Borrowers are then required to make regular repayments that include interest and sometimes principal (if the loan is fully amortizing). As the loans are repaid, the private credit funds distribute earnings to investors, often through monthly or quarterly repayments.
This structure can provide investors with a steady source of cash flow throughout the life of the loan, along with a return of the principal once the loan is paid off. Additionally, private credit can support portfolio diversification and often offers downside protection through floating interest rates and senior positioning in the borrower’s capital stack. On the downside, it does typically lock up capital for extended periods, and investors assume the risk that a borrower could default. To learn more about this asset class, see The Rising Popularity of Private Credit.
Private real estate
Private real estate is an asset class that involves direct or pooled ownership in real estate properties that aren’t traded on public stock exchanges. Private funds pool money from investors, and a real estate expert uses the money to acquire, develop, manage and sell properties. Returns for investors then come from rental income as well as appreciation when properties are sold.
Unlike public REITs, which are traded daily in public markets, private real estate investments require you to commit capital for many years. However, they also tend to offer higher returns and enhanced portfolio diversification relative to traditional investments, such as mutual funds or index ETFs.
Infrastructure investments
Private infrastructure investments are long-term equity or debt investments into the construction or improvement of essential structures that societies rely on for services, like utilities, digital networks, dams and roads. Infrastructure funds pool money from investors to invest in a portfolio of infrastructure assets. In return, investors can potentially receive consistent revenue from the services provided by the assets, such as user fees, utility rates or long-term contracts. There’s also potential for capital appreciation when an asset sells.
Investing in infrastructure funds can offer an inflation hedge, downside protection and low correlation to traditional asset classes. However, these strategies carry various risks primarily due to illiquidity, potential project disruptions and asset depreciation from external factors, like technological innovation and environmental, social and governance (ESG) issues.
Secondaries and co-investments
Secondary private investments (also known as secondaries) refer to buying existing stakes in alternative investment funds, often in private equity, real estate or venture capital. In certain cases, existing investors or fund managers may want to divest from their ownership (typically because they need liquidity). You can then step in to purchase their interest, typically at a discount. This strategy can be appealing because it offers quicker diversification and a shorter investment period, along with the ability to see how the underlying assets have been performing thus far.
Co-investments refer to investing directly into a specific company alongside a private equity fund manager. Fund managers may ask investors to do this when deals are too large for their main fund, or to offer them value-add opportunities. The benefits are often lower management fees, more control over the investment and greater transparency compared to a blind-pool private equity fund.
Impact investing and ESG integration
Private equity impact investing refers to investing in privately held companies, projects or funds that focus on generating a measurable, positive social or environmental impact, along with a positive financial return. This can be done through various private assets, including PE, infrastructure, real estate and private credit. When choosing investments, ESG data should be analyzed alongside traditional financial data to get a complete picture of an organization and its actual impact.
Why Consider Private Market Investing?
Private market investing is worth considering, because it can offer enhanced return potential, portfolio diversification, downside protection and access to unique investment opportunities.
Private market investments have shown they can provide higher returns when compared to traditional asset classes over long time horizons. As the return comparison charts below illustrate, private equity and credit have delivered higher average returns than their public market counterparts.
Similar outperformance has also historically occurred between private and public credit, as illustrated in the chart below.
Private markets can also support diversification, leading to downside protection. Because private investments often have a low correlation to public markets, they can help smooth volatility and provide resilience during economic disruptions. Additionally, private market managers may have the flexibility to adapt strategies quickly, allowing investors to capitalize on dislocations when opportunities arise. For more on this theme, see Diversification Strategies for Various Markets.
Further, private markets offer unique access, opening the door to private companies, specialized lending strategies and opportunities not available through public exchanges. For UHNW investors, integrating private investments into your strategy can help create a more well-rounded, profitable and resilient portfolio. Learn how Creative Planning supports the process through our comprehensive affluent wealth management strategies.
Key Considerations for Private Market Investing
While the potential benefits of private market investing can be compelling, there are also a few potential drawbacks to consider.
1. Higher fees and cost structures
Private market investments tend to have higher costs than the sub-1% expense ratios common with public market investments. The most common cost structure is known as the “2 and 20” model. The 2 represents an annual management fee equal to 2% of the fund’s committed or invested capital. The 20 is a performance-based fee (carried interest) equal to 20% of the profits generated by the fund. However, carried interest is often only charged after a minimum annual return is met. It’s important to always investigate all of an investment’s costs and consider negotiating reduced management fees.
2. Illiquidity and lock-up periods
Investing in private market assets generally requires longer lock-up periods. Many of the asset classes, notably private equity, private real estate and private infrastructure investments, require long-term investments to grow and generate returns. You’ll often need to commit capital for anywhere from five to 12 years. However, these investments pay an “illiquidity premium” in exchange for the inconvenience. In other words, you can potentially earn higher returns than are available from more liquid public market investments due to the lack of flexibility and increased risk.
3. Complexity and transparency challenges
Private market investments tend to be more complex and less transparent than their public market counterparts. For example, private companies have fewer regulatory disclosure requirements than public companies, which can make it challenging to perform due diligence. The absence of an active secondary market also makes valuing private assets more subjective.
Investors must navigate layered structures, including waterfall provisions, covenant packages and K-1 distributions. These can introduce tax implications, such as potential unrelated business taxable income (UBTI) exposure in certain accounts, and may require specialized investment and tax guidance.
4. Higher risk profiles
Private market investments typically carry higher risk profiles than public assets. Their illiquid nature makes it harder to adjust positions or exit during downturns, while limited transparency can complicate accurate valuation. In addition, private funds often hold fewer underlying investments than public market indexes, increasing concentration risk. And some strategies are more speculative, relying on leverage, aggressive growth assumptions or operational turnarounds.
5. The critical role of due diligence
Effective due diligence is essential in private market investing and typically includes a comprehensive review of the investment manager and strategy. Vetting steps can include a review of the following:
- Track record analysis across multiple market cycles
- Strategy consistency, including alignment between stated objectives and execution
- Value-creation approaches, such as operational improvements, pricing power or disciplined capital deployment
- Financial analysis, including leverage, cash-flow durability and downside scenarios
- Operational and ESG assessment to identify governance, regulatory or sustainability risks that could affect long-term outcomes
A disciplined due diligence process can help protect you against the potential downside that can come with private funds and other private market investments.
Integrating Private Market Investments Into Your Wealth Plan
Private market investments have pros and cons, like any investment class. However, they’re often a strong fit for UHNW investors and other qualified investors with large capital bases, long time horizons and minimal liquidity needs. With a qualified professional on your side performing thorough due diligence, you can work to limit downside risk while taking advantage of key benefits, like enhanced return potential and protection against market shocks.
Frequently Asked Questions About Private Market Investments
What is private market investing?
Private market investing involves investing in assets, such as private real estate, private infrastructure, private credit and private equity, that aren’t traded on public exchanges. Fund managers pool money from investors, using it to invest in various assets and pay out earnings to investors. These investments tend to be less liquid, more costly and more risky than public market assets. However, they can offer enhanced return potential and portfolio diversification.
Why invest in private markets?
You may want to allocate funds to private market investments to diversify your portfolio. While public markets are known to be relatively stable and reliable in the long term, recent economic events have left some investors feeling less confident in them. Private market investments have a low correlation to public markets, which can potentially help provide downside protection during public market downturns. They also tend to offer higher returns to compensate for longer capital lock-up times and higher risk.
What are the risks of private market investments?
Private market investments generally present several risks, including illiquidity due to long lock-up periods, reduced transparency compared to public markets, and valuation risk driven by more subjective pricing. Investors also face capital risk (as returns aren’t guaranteed) and broader market risk during economic downturns. Risk levels can vary significantly between investments based on factors like asset class, fund structure and the experience of the fund manager.
