Your Guide to Private Markets Investing

Investors have been looking beyond stocks and bonds lately, as they search for ways to diversify their portfolios in the wake of historic market volatility.

Real estate, cryptocurrency, precious metals, and private business investment are all grabbing investor attention for very different reasons–yet they all fall under the same umbrella term: ‘private markets.’

In this article, we'll explore the benefits and risks of investing in these somewhat opaque asset classes. We’ll delve into the importance of secondary markets for liquidity and strategies for incorporating private markets into a broader portfolio. Additionally, we'll examine how digital technology is making private markets investment more accessible to individual investors.

Key Takeaways

• Private markets offer the potential for higher growth and unique investment opportunities, but come with risks like limited liquidity and higher fees
• Secondary markets play a crucial role in providing liquidity and valuation enhancement for private markets investments.
• Digital technology is lowering the barriers to entry, making private markets investments more accessible to a wider range of investors.

What is a Private Market?

Private markets encompass a range of investment types, none of which are listed on public exchanges. These markets are generally less regulated and provide less transparency than public markets, and typically appeal to investors seeking higher returns and who are able to stomach a larger degree of risk.^[1]

The term ‘private markets’ often refers to private equity, private credit, and venture capital. Each of these sectors can further be fragmented into their own subsectors (for example, private credit contains direct lending, leveraged loans, and distressed credit).

Investment in private markets has typically come from institutional or high net worth investors, given the significant capital commitment needed to participate.^[2] Though in recent years, digital platforms have sprung up which facilitate individual investor access to private markets opportunities.

What is a Secondary Market, and How Does it Play a Role in Private Markets?

A secondary market is a platform that facilitates the sale and purchase of existing securities. For example, the stock market can be thought of as an enormous secondary market–every time you buy shares of a company, someone else is selling you those shares, hence the ‘secondary’ nature of the transaction.

Secondary markets are essential for liquidity purposes, as they enable investors to exit their positions before a company's public offering or sale/merger. This ensures that investments retain their value through active trading–having a robust secondary market in place enhances the value of the underlying securities bought and sold on that market.

By offering liquidity and opportunities for portfolio reallocation, secondary markets enhance the appeal of private markets. They open the doors for investors seeking to access funds or explore new opportunities, making private investments more accessible and potentially more rewarding.

As Goldman Sachs Asset Management puts it: “The secondary market is considered crucial for the liquidity and valuation of private market investments because it provides liquidity solutions to LPs looking to reshape their portfolios or adapt investment strategies in a dynamic environment."^[3]

Benefits and Risks of Investing in Private Markets

The private markets landscape is rife with opportunities and obstacles alike. Investors may face liquidity constraints, less regulatory oversight, and the risk of investing in emerging companies with a limited track record. However, the potential for substantial growth, unique investment opportunities, and enhanced portfolio performance makes private markets investment an attractive option for those willing to navigate its complexities.^[4]

Below are some of the major risks associated with investing in private markets:

• Limited Liquidity: Often, private markets investments will lock up investor capital for many years. Digital platforms like Heron Finance are revolutionizing liquidity opportunities within private markets investment (learn more here.
• Less Mature Companies: Often, private markets investors are investing in companies without extensive track records (in the case of venture capital, no track record!). This is not always true–as there are many private companies that have been around for decades. That said, typically, a private markets investment will occur in a business with less than 10 years of track record. Contrast that with publicly-traded companies, and it’s easy to see how the risk of uncertainty arises in private markets investment.
• Lack of Regulatory Oversight: Private companies aren’t subject to the same regulations as their publicly-traded counterparts. This affords investors an extra degree of risk (on the flip side, lack of regulations can help facilitate accelerated growth).

And here are some of the benefits that draw investors to private markets investment:

• Potentially Superior Risk-Adjusted Returns: The returns on private markets investment often outpace those of public markets (stocks and bonds). Private credit, for example, has outperformed the S&P 500 over the last 30+ years.^[5]
• Reduced Portfolio Volatility: Private markets investment allows investors to diversify away from the stock and bond markets, which in recent years have grown more tightly correlated.^[6] This can help smooth out an overall portfolio should the stock and bond markets face a period of volatility.
• Diversification: Private markets can provide access to unique investments and sectors underrepresented in–or completely absent from–public markets.

How Should Investors Incorporate Private Markets Investment into Their Overall Portfolio?

Determining the appropriate portfolio allocation to private markets is a personal decision on the part of every investor, however, prominent financial institutions are recommending that their clients shift away from the traditional 60/40 portfolio into one that encompasses private markets investment.^[7] 40/40/20, or 33/33/33 splits are being introduced, with many prominent institutions such as CalPERS, the largest public pension fund in the U.S., upping its private markets allocation percentage.^[8]

Like all investments, the investor’s risk tolerance and financial objectives are crucial when determining private markets allocation. Yet the potential for both outsized returns and lower overall portfolio volatility means that private markets investment has a role to play in both aggressive and conservative portfolios.

For a deeper dive into how prominent institutions are allocating to private credit specifically, read our recommendation on portfolio allocation to private credit.

How is Digital Technology Impacting the Adoption of Private Markets Amongst Mainstream Investors?

Digital technology is revolutionizing access to private markets, making these investments more attainable for mainstream investors. Through online platforms, the barriers that once limited entry to high-net-worth individuals and institutional investors are being dismantled.

These platforms not only lower the entry threshold (in the case of Heron Finance, accredited investors can access private credit investments with as little as $100), but they can also help facilitate the growth of the industry as they attract individual investors into private market opportunities.

In short, the landscape of private market investments has evolved significantly, offering accredited investors opportunities for diversification, the potential for superior returns, and access to unique investment opportunities. Digital technology plays a key role in simplifying the investment process and providing educational resources to empower investors.

If you’re an accredited investor who would like to get started investing in private markets today, click the button below to set up your Heron Finance account.