Private Equity: An IntroductionSeptember 14, 2018
Private equity has gained a great amount of influence in today’s financial marketplace, but surprisingly, many investors are unfamiliar with it, potentially causing them to miss out on investment opportunities. This blog briefly touches on the basics including what it is, who have traditionally invested in it, and why you should consider it as an alternative investment.
In simple terms, private equity is an asset class consisting of investments in companies that are not traded on a public exchange.
Public equities, on the other hand, are those that are traded on an exchange like the Toronto Stock Exchange (TSX), the New York Stock Exchange (NYSE) or NASDAQ.
Who Has Traditionally Invested in Private Equity?
The ‘smart money’ have been investing and, more importantly, increasing their investments, in private equity for years. Examples include pension funds, endowment funds, family offices and ultra-high net worth.
Take U.S. endowment funds, for instance, (like those at Yale and Harvard) that have averaged 53% in private equity (NACUBO – Commonfund Study of Endowments) or even pension funds (like OMERS) that are close to 50% (45% in 2016) in private equities, and you can see why they are so ‘smart.’
The smart money in the market is perceived as being invested by people who have a better understanding of the market or access to information channels that a regular investor can’t easily access.
5 Reasons Why You Should Invest in Private Equity
1. Accessibility. It’s currently an ‘opportunistic market’ where certain private equity investments are available to all Canadians; it’s no longer just for the wealthy.
2. Higher returns (on average) paid out on distributions. In exchange for less liquidity, you may earn higher returns. The concept is called the liquidity discount, that is, private investments sell at a discount for the same return – apples to apples. Alternatively, public investments are priced at a premium in exchange for liquidity.
3. True diversification. Most investment portfolios contain a mix of investments: stocks (various sectors like: energy, financials, technology, healthcare etc.), mutual funds (pools of various stocks), ETFs and bonds. The traditional diversified portfolio is usually all public investments, and with everything being concentrated in public investments, one is not fully diversified.
4. Not volatile like the public markets. Private equity investments tend to have more stable pricing. For example, with a private REIT, values are based on apartment buildings which are hard assets whose value does not fluctuate regularly. Private investments typically do not move based on the emotions of the marketplace.
5. Uncorrelated returns. Private investments can have returns/performance that is not necessarily correlated to the public markets, which helps diversify a portfolio. ‘Correlation’ is the degree and type of relationship between any two or more variables in which they vary together over a period.