Every day, earnings are scrutinized, acquisitions are dissected, and management hirings and departures are prominently featured — public markets capture our full attention. Perhaps that’s a collective oversight.
often need capital to finance their day-to-day operations and grow their businesses.
create and manage investment funds, which deploy capital on behalf of a pool of investors.
seeking diversification, reduced risk, or more attractive returns can make investments in companies that are not accessible via public markets.
However, the desire for flexibility and control is routinely at the heart of this decision. Raising capital through public markets, such as an initial public offering (IPO), comes with a slew of regulatory requirements, increased scrutiny from the public, and the pressure of quarterly earnings expectations. These factors can sometimes divert a company's focus from long-term growth to short-term performance metrics, possibly compromising sustainable value creation. Alternatively, private capital allows businesses to secure the funding they need without subjecting themselves to the whims and fluctuations of public markets.
There are many investible strategies within private markets, but they can be broadly grouped into three categories:
Private equity refers to making investments in the equity of companies that are not listed on a public stock exchange. Private equity managers create investment funds in which they identify, diligence, purchase, and manage investments in these private companies on behalf of their investors. Ultimately, their goal is to add value by actively managing or restructuring the businesses, typically over a period of 4–7 years, to generate a profit for shareholders upon exit. For investors, private equity seeks to deliver long-term capital appreciation and reduced volatility relative to public equity.
There are many types of strategies that fall under the private equity umbrella, but they can be generally categorized by the stage of the business life cycle that target investments are made in.
Venture Capital (VC) pertains to investments in early-stage companies with high growth potential. These companies are often in innovative industries and may not have a proven track record or significant revenue streams yet, so managers face the possibility that they may not always survive. VC firms provide capital in exchange for equity (usually a minority stake), effectively investing in the company's future. The goal is to invest early, help the company grow, and eventually exit with a substantial return, possibly through a sale or an IPO.
Growth Equity sits between venture capital and buyouts in the investment spectrum. It involves investing in established, growing companies. They are usually further along in the business cycle than typical VC targets — perhaps even profitable — but they still need additional funds to scale, restructure operations, enter new markets, finance acquisitions, or otherwise achieve the next phase of growth.
Buyouts involve acquiring a controlling interest in a company, typically to make operational improvements and then sell the company at a profit. Targets for buyouts tend to be more mature companies with stable revenues that have the potential for further growth under the guidance of a private equity manager. Leveraged Buyouts (LBOs) are a subset of buyouts where the acquisition is financed with a significant amount of borrowed money that is secured by the company's assets or cash flows.
Secondaries is a newer strategy that is rapidly growing as private equity managers seek to hold onto their best portfolio companies beyond the life cycle of existing private equity funds. By selling these trophy assets to what are called continuation funds, managers can continue creating value while creating an exit for shareholders. These transactions can be especially useful in challenging exit environments, preventing managers from being forced sellers of performing assets.
Private credit typically refers to the provision of credit by non-banks directly to private companies. Over the last 30 years, banks have decreased their participation in lending by over 65%2, leaving a host of high-quality companies with less access to traditional financing. Private credit providers fill this gap by structuring and issuing various types of loans, passing through periodic interest payments to their investors via distributions. These loans are not syndicated or sold on a secondary market, they are held by the lenders to maturity (typically 5–7 years).
From the standpoint of investors, private credit can offer income at a yield premium to public fixed income, with lower interest rate sensitivity relative to public debt. Much like the medley of private equity solutions, private credit offers a range of strategies to invest in the debt of private companies.
Direct Lending refers to the provision of loans to companies without the involvement of an intermediary, like a traditional bank. This strategy has become the largest and most common in the private credit space, particularly as banks have widely reduced lending activity. In turn, private credit funds play a key role, offering loans to private businesses that are seeking flexible capital solutions. Borrowers can use these loans for a variety of purposes, including growth initiatives, refinancing existing debt, or funding acquisitions. Direct lenders tend to focus on senior debt at the top of a company’s capital structure.
In recent years, direct lending has become an increasingly popular source of financing for private equity buyouts. In many cases, private credit providers can offer customized solutions and forge long-term partnerships, making them an attractive option for buyout firms looking for capital to support their acquisitions.
Mezzanine financing is a hybrid form of capital that resides between senior debt and equity in a company's capital structure. It can offer higher interest rates than senior loans in exchange for increased risk due to its subordinated position, meaning it is paid back after senior debt in the event of a default. Mezzanine financing can also include an equity component, such as warrants or conversion rights, allowing the lender to convert debt into equity under certain conditions, potentially presenting additional upside if the company performs well.
Distressed debt involves purchasing the debt of companies that are facing financial challenges or are on the brink of bankruptcy. Investors in distressed debt aim to profit either by buying the debt at a significant discount and potentially earning a return if the company recovers or by gaining control of the company's assets in a restructuring or liquidation scenario.
Private real estate refers to the direct investment in physical properties outside of publicly traded entities. This market spans a broad array of industries and building types, including residential, commercial, industrial, and special use. With the right strategies and management, private real estate can serve as a steady, inflation-resistant component of a diversified investment portfolio.
Private real estate investments are typically categorized into four strategies, depending on their objectives.
Core real estate investments are characterized by their lower risk and stable returns. They tend to involve well-located, fully leased, high-quality properties in established markets. These properties often have long-term leases in place with creditworthy tenants, providing a consistent income stream. Core investments are generally financed with low levels of debt and offer investors predictable cash flows with minimal exposure to capital appreciation.
Core Plus investments are a slight step up the risk ladder from Core. While they still focus on high-quality properties, these investments might need light upgrades or repairs. The objective is to achieve moderately higher returns than Core by taking on a bit more risk and relying on more leverage to finance investments.
Value-Add investments represent moderate- to high-risk properties that require a more active management approach to realize their full potential. In many cases, these properties can have high vacancy rates, minimal cash flow, management issues, or extensive repair needs. The goal is to achieve higher returns by adding value through various strategies, such as property improvements, repositioning, or lease-up initiatives. Once additional value is unlocked and cash flow has improved, assets may be sold to Core or Core Plus investors.
Opportunistic investments represent the highest risk and potential return in the private real estate market. These investments target distressed assets, significant redevelopment projects, land development, or emerging markets. The strategy could involve changing the property's use, undertaking extensive renovations, or even ground-up redevelopment. Given the higher risk, opportunistic investments aim for higher returns.
There’s a reason why alternative investments have remained a fixture in the portfolios of institutional investors for decades. Private markets are robust, with many investable opportunities across asset classes and strategies that can offer a range of potential benefits — attractive returns, increased income, reduced volatility, enhanced diversification, and the comfort that comes with prolonged wealth accumulation and capital preservation.
While no one has a crystal ball to see into the future of financial markets, the momentum behind the growth of private markets is quite clear. Private equity, private credit, private real estate — each segment is anticipated to amass billions of dollars in additional assets under management in the coming years5 as these investments, which institutions have historically had access to with great success, have become more affordable, conducive, and curated for individual investors. Yet, despite their merits, many investors remain underexposed to these opportunities, overlooking what should be viewed as core components in a well-rounded, diversified investment strategy.
Unless otherwise indicated, the information referenced herein is as of September 2023.
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