An Introduction to Public versus Private Investments
The issue of private assets has been one of the most pressing topics we have fielded questions from recently. From existing adviser-clients developing their own knowledge to have meaningful discussions with their prospects, to questions and debates we’ve observed at industry events, the act of owning private assets which do not frequently mark-to-market is a developing point of contention.
As part of a potentially longer-term line of discussion – and to avoid throwing our hat into the ring in what is a short-form communication format – today we will provide a brief introduction into the differences between public and private investments, the risks/opportunities and what dynamics investors should be aware of in a broader portfolio context.
Private vs Public Assets
Most investors are far more familiar with the workings of public assets, securities which are freely tradeable between parties in some form of secondary market – the most obvious example of this is a stock exchange, however this also includes trading government bonds, over-the-counter corporate credit, and listed REITs of course.
When we say familiar, we mean that nearly every investor has likely:
- Bought and sold a stock on an exchange
- Held an equity fund in their portfolio
- Held a bond or credit fund in their portfolio
- Held a REIT or an infrastructure fund in their portfolio
These are highly liquid holdings which take up the bulk of investor’s general financial education and the vast majority of financial media emphasis. They can be readily bought and sold at will (within reason) and have counterparties working in the background to ensure a smooth onboarding/offboarding experience, such as brokers, fund administrators and custodians (such as your bank).
What many investors are less familiar with is the opaque universe of private assets, those which are not openly traded on a secondary market and in fact often do not change hands for many years. This may include a private equity investment in a small growth company, holding a line of securitized debt over an office building or simply owning the office building itself (or at least a stake in it).
Private equity (PE) broadly involves an investment made into a company which is not yet listed on a stock exchange. PE investors will take a stake in generally a young and small company – although not always – and look to work with management to transform the business into something which can be either bought by another PE firm for a higher price, or listed on an exchange to allow existing shareholders to sell-out. Either of these scenarios is termed a “liquidity event” or “exit event” – we’ll come back to liquidity soon.
Private credit (PC)can be thought of similarly, and in fact is probably more comfortable for most investors to relate back to their own financial scenario. Private credit is simply an agreement which is negotiated and executed between parties for some form of debt obligation, which is not publicly tradable on a secondary market. That might make it seem simpler than it is, so we’ve included a helpful graphic from PIMCO below to help illustrate the credit universe:
Private infrastructure and property are even more familiar to most investors. Similar to owning a single home, most private real estate investments are investments into single assets. Office buildings, retail centres, build-to-rent apartment blocks are a few of the many examples of assets – it’s less likely you own a toll road, pipeline or airport, but via an investment into a private infrastructure fund you could at least gain exposure.
What are the risks?
Rather than get into a discussion about if you should hold public versus private – again, a nuanced topic which requires far more space than 800-1,000 words – we want to briefly outline the major risks associated broadly with public versus private markets.
As risk-focussed investors, we believe that understanding the risks you’re exposed to is paramount to any allocation decision, and should be considered well before considering the proposed return of an investment.
Public markets are exposed to the following (non-extensive) list of factors:
- Market risk (an asset moving with broad market fluctuations)
- Currency risk (the currency of an asset changes relative to the purchasing currency)
- Duration risk (the sensitivity of an asset to changes in interest rates)
- Valuation risk (the sensitivity of an asset to being under/overvalued)
Again, many of these most investors would be familiar with – we certainly discuss these risks ad nauseum in our investor updates and in many of these weekly digests.
Private markets tend to experience some risks more specific to that style of asset:
- Liquidity risk (assets cannot be bought and sold on-demand in a secondary market)
- Execution risk (similar to market risk, private deal fails or becomes less appealing)
- Minimum investment size (direct or fund investments have much higher minimums)
- Mark to market risk (assets are not priced frequently, leading to the misconception that the investment is less volatile)
All risks can be managed in the context of a robust, multi-asset portfolio – it is the role of the capable investment manager to be aware and account for all risks that any one asset might bring into the portfolio, hence the focus on “risk-adjusted returns”.
As mentioned previously, we are aware that this is a pressing issue for many of our clients, and though we do have opinions the ‘public versus private’ conversation requires far more nuance and depth than is allowed in a single note. We are always happy to field questions regarding our thoughts and findings on this matter, and if wanted we can initiate a public versus private series of weekly notes.