How investors define private markets
Private markets allow buyers and sellers to trade assets through direct negotiation with one another rather than through an intermediary, such as a public securities exchange. Anyone who has bought or sold, say, a business or a home knows something about trading a private asset. Investing in private markets can fall into one of two broad categories:
1 Investing in companies, by providing equity or debt financing to private businesses unable or unwilling to access capital through stock or bond markets
2 Investing in things, known as real assets, such as office towers, toll roads, timberland, and farmland
The key feature of private markets is lack of liquidity, which presents return measurement and valuation challenges. With those challenges come opportunities for long-term investors. Here we list common questions and our answers about private markets.
1 What’s the difference between investing in public markets and investing in private markets?
Liquidity is the dominant differentiator between public markets and private markets. While public markets are highly liquid, private markets have liquidity constraints. Liquidity refers to how quickly an investor can convert an asset into cash while maintaining its value. An asset that can change hands quickly and easily can be described as liquid. One that takes longer to sell is considered less liquid—illiquid.
To buy or sell stock in a public company, an investor needs little more than an online brokerage account, a Wi-Fi connection, and a few minutes; trade execution is relatively efficient and transparent. By contrast, investing in a private asset requires finding an interested counterparty, negotiating mutually agreeable terms, engaging legal counsel to draft contracts, and many other steps that require planning, effort, and expenses; moreover, private investments can’t be valued reliably until they’re sold.
Private markets tend to offer higher expected returns, related in part to an illiquidity premium, to compensate investors for committing to longer holding periods. Large institutional investors, such as pension plans and insurance companies, can use illiquidity to their advantage by diversifying their portfolios with private assets that match their extended investment horizons and their return targets.
Liquidity isn’t the only distinguishing characteristic. Private markets also offer investors greater breadth of opportunity and alpha sources. While there are thousands of publicly traded companies globally, there are millions of private firms across the world. Private asset strategies have also demonstrated a wider range of return dispersion than those investing in public markets.
2 What are the different types of private assets?
Investments in private markets—ranging from distressed debt to fine art—can be as different from one another as they are from more traditional holdings. The following private markets categories cover investing in companies and investing in things.
Private equity investments
Investors in private equity pursue capital appreciation by taking ownership positions in unlisted companies. While fundamental to entrepreneurs who own their own businesses, private equity is also accessible to outside investors through primary funds or direct investments.
- Innovations within a growing secondaries market for private equity are also opening broader areas of access to the asset class.
- Private equity includes minority positions in early-stage venture capital and control buyouts of mature companies.
- Investors seek to accelerate the growth of the business before an initial public offering, acquisition by a competitor, or sale to another financial buyer.
Private credit investments
Investors in private credit give up liquidity to pick up yield by holding debt of unlisted companies. While investors holding bonds can sell their positions as they please, private credit investors are committed to longer-term relationships with their borrowers.
- Private credit includes, for example, investment-grade private placements, real estate debt, and venture capital loans.
- Loans mainly fall into two categories: real asset loans (financing things) and corporate loans (financing companies).
- While investors providing senior credit to a company generally seek income and preservation, investors in junior credit can pursue income and appreciation.
Real estate investments
Investors in commercial real estate can seek a wide range of risk/return objectives. Real estate investments include apartments, hotels, office towers, industrial parks, and retail properties. In addition to structures and the land, an investment can include air rights above the land and ground rights below the land.
- Driven by contractual rent payments, core and core-plus strategies tend to invest in fully operational and occupied properties.
- Value-add strategies seek higher returns by purchasing properties with an intent to improve them before selling.
- Opportunistic strategies can hold more speculative or even distressed and unoccupied properties with greater capital appreciation potential.
Infrastructure assets—such as electric and water networks; power-generation plants; highways, railroads, and airports; and telecommunication towers—provide essential services related to the safeguarding and movement of people, goods, energy, food, and data.
- Infrastructure investors can benefit from limited competition and stable consumer demand throughout the business cycle.
- Stable long-term contracted cash flows or regulated real rates of return underpin income generation for infrastructure investors.
- Infrastructure assets can demonstrate a greater degree of insulation against macro risks, such as an economic recession or unexpected inflation.
Investing in agriculture involves managing physical assets such as farmland, including irrigation systems and grain storage, and for orchards and vineyards, trees and vines.
- Crops are planted, managed sustainably, harvested, and sold in food markets.
- Vertical integration—also known as farmland plus, or core-plus, agriculture investing—can reduce volatility relative to crop-only investment and help control third-party processing costs while enhancing crop marketing.
- Agriculture investments can help boost risk-adjusted total returns, generate income, preserve capital investment, realize long-term appreciation, and have a long history of generating strong financial results and low correlations with other asset classes.
Timberland’s long history of delivering competitive and consistent cash yields, inflation protection, and capital appreciation has provided incentive for investors to include the asset class in their portfolios.
- Additionally, the growing number of corporate commitments to net zero emissions and global attention to climate change and carbon markets is creating new opportunities to manage forests for carbon value, as well as for timber value.
- A growing and increasingly broader base of demand is likely to strengthen forest property values as voluntary carbon offsets continue to reshape timber markets.
3 Why do investors turn to private markets?
Investors allocate to private markets to pursue higher expected returns, to reduce price volatility, and to keep pace with current best practices in portfolio diversification.
To pursue higher expected returns
While stocks have generated substantial wealth for investors over time, private assets can benefit from potential sources of returns unavailable in public markets. Since investments in private markets are relatively difficult to price and trade, they’re more likely to generate excess returns to reward investors for assuming additional complexity.
To reduce portfolio volatility
Stock and bond prices are marked to market, changing in real time as investor sentiment shifts. Many private assets, by contrast, are appraised quarterly; as a result, allocating to private markets can have a smoothing effect on a portfolio, lessening its price volatility as market action fluctuates from day to day.
To keep pace with best practices in diversification
Investors also allocate to private markets to stay current when it comes to portfolio diversification. Holdings that are viewed as safe in isolation, such as government bonds and preferred stock, dominated institutional investment portfolios as recently as a century ago. While corporate bonds and common stocks were widely regarded as too risky at that time, they were later embraced as diversifiers, becoming portfolio staples over subsequent decades. Along with our economy, investing norms and best practices are continuing to evolve to this day. Demonstrating lower correlations with public markets, private assets can help investors stay on the cutting edge of portfolio diversification.
Investing norms and best practices evolve over time
|Popular institutional-quality assets over time
|Government debt, real estate, mortgages, preferred stock
|Add high-quality corporate bonds, domestic equities, agricultural debt
|Add average-quality corporate bonds, international equities
|Add high-yield debt, small stocks, structured products, private equity, hedge funds, real assets
What’s next for private markets?
The benefits of investing in private assets have historically accrued only to the largest and wealthiest investors; however, access to private markets has been expanding in recent years through new fund structures with lower investment minimums, some of which allocate to multiple asset classes, with a goal of delivering clients diversification and liquidity management in a single allocation. Other private markets strategies are designed to help investors meet specific needs, such as inflation hedging, downside protection, or income generation. Structural innovations in asset management, along with growing regulatory support and a greater need for more attractive risk-adjusted return prospects, suggest there’s room for private assets in a growing number of portfolios. We expect the years ahead will bring more investors into private markets capabilities that can complement and diversify their portfolios beyond bonds and stocks.
1 U.S. timberland is represented by the NCREIF Timberland Index. U.S. farmland is represented by the NCREIF Farmland Index. U.S. Commercial Real Estate is represented by the NCREIF Property Index. U.S. small-cap equities are represented by the Ibbotson series IA SBBI U.S. Small Stock TR USD Index. Non-U.S. equities are represented by the MSCI EAFE Index. U.S. long-term corporate bonds are represented by the Ibbotson series IA SBBI U.S. LT Corp TR USD Index. U.S. Treasury bills are represented by the Ibbotson series IA SBBI U.S. 30 Day Tbill TR USD Index. Commodities are represented by the U.S. Bureau of Labor Statistics. U.S. large-cap equities are represented by the S&P 500 Index. Private debt and infrastructure are both represented by the Burgiss Indexes. Public forest products are represented by the S&P Composite 1500 Paper and Forest Products Index. Private equity is represented by the Cambridge Associates Private Equity Index as of September 30, 2021 (all other data as of December 31, 2021). It is not possible to invest directly in an index. Past performance does not guarantee future results.
A widespread health crisis such as a global pandemic could cause substantial market volatility, exchange-trading suspensions and closures, and affect portfolio performance. For example, the novel coronavirus disease (COVID-19) has resulted in significant disruptions to global business activity. The impact of a health crisis and other epidemics and pandemics that may arise in the future could affect the global economy in ways that cannot necessarily be foreseen at the present time. A health crisis may exacerbate other preexisting political, social, and economic risks. Any such impact could adversely affect the portfolio’s performance, resulting in losses to your investment.
Investing involves risks, including the potential loss of principal. Financial markets are volatile and can fluctuate significantly in response to company, industry, political, regulatory, market, or economic developments. These risks are magnified for investments made in emerging markets. Currency risk is the risk that fluctuations in exchange rates may adversely affect the value of a portfolio’s investments.
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