Public and Private Equity
Asset classes, the growing popularity of private equity, options for investing in companies, and comparing returns over time
Investing is a relative game. A good or great investment depends on the options available.
Today, investors have a wide array of options to choose from.
Each investment opportunity brings its own uniqueness to the mix. Different opportunities have different characteristics regarding risk and reward.
In order to find the best investment opportunities, an investor must know and understand the landscape of available options.
Asset Classes and Private Equity
At the highest level, investments are classified into various asset classes.
The public markets offer access to listed equities, listed bonds, commodities, and more. These investments trade on well-known exchanges such as NYSE and NASDAQ.
Assets beyond the public markets are often referred to as alternative assets. This is a broad ranging class, including everything from venture capital to crypto, art, and collectibles.
The private capital markets is a significant component of the alternative assets landscape, and is often considered as three major parts:
Private equity
buyout private equity
venture capital
growth capital
Real assets
real estate private equity
natural resources private equity
infrastructure private equity
Private debt
As implied by their name, these investments are private and require that an investor have access to the right network of people.
Growing Popularity of Private Equity
Over the last few decades there has been an increasing interest and activity in private equity.
Private equity is encroaching on the traditional stock-bond portfolios, taking on an increasingly larger allocation.
There has been an explosion in the number of firms participating in the rise of private equity. Private market firms are on a steep rise, having now surpassed the number of hedge funds.
Returns for private equity have been generally quite attractive.
As mentioned in the introduction, the attractiveness of any particular opportunity depends on the options available.
Investing in Companies
Listed equities, buyout private equity, and venture capital are all related to ownership of an operating company, albeit with important distinctions.
Listed equities, colloquially known as stocks, involve purchasing a small fraction of a publicly traded company. Because of the stringent reporting requirements, public companies tend to be larger in size. While investors can influence decisions, such as through activist activity, it requires a significant capital base and is relatively rare.
Buyout private equity typically involves purchasing an entire company, often with an active agenda to enhance operations by applying financial leverage, improving volume, and/or increasing margins. Buyout private equity investments often involve an exit plan, looking to sell the company after a predetermined time horizon, often 3-7 years.
Well-known private equity firms include KKR, Blackstone, Carlyle, Thoma Bravo, amongst many others.
Venture capital typically involves investing in rapidly-growing companies with a lot of promise. Venture capital firms may invest early on as the company is developing, in seed or early stages. They may also focus on growth investing, providing capital for later-stage, larger companies.
Although they often seek a seat on the board, venture capitalists rarely acquire a majority of the company. Rather, they are typically structured such that the founders maintain healthy equity to be incentivized to lead and grow the business. Venture capitalists offer support and guidance, but often take a more passive role than buyout private equity firms.
Well-known venture capital firms include Bessemer, Andreessen Horowitz, General Catalyst, TCV, Sequoia, amongst many more.
Each of these approaches is quite different.
An investor should consider the implications of each approach, such as the amount of effort required from the investor, the downside risk, and the potential upside reward.
Comparing Returns
Public markets have rigorous reporting requirements and a highly active, liquid market. This dynamic allows for consistent tracking and performance reporting over time.
The stock market’s average annual return since 1928 has been roughly 10%. See Investing in Equities for the Long-Term for more details.
Private markets are different. There are many different methods to measure performance and, therefore, it is not surprising for different studies to come up with different numbers.
By looking at a broad range of studies and reports, investors can build an intuition around expectations of each approach.
Venture capital appears to be the highest risk, highest reward class, with a large performance spread from -25% to +45%.
In the same report, buyout private equity performance ranged from roughly -30% to +30%.
A second report on venture capital performance backs up the outperformance.
It has not always been the case -- the outperformance by venture capital appears to have started around 2005.
Buyout private equity firms seem to be resilient, demonstrating stable performance over time.
The top buyout private equity firms seem to consistently deliver returns in the 15-25% range.
The remaining firms, however, do not do so well. The median returns hover around 10%, more akin to stock market returns. The bottom quartile is essentially breaking even.
Historically, buyout private equity has outperformed stocks.
In recent years, however, the gap appears to be closing.
According to one report, for a ...
30-year period, buyout equity outperformed the S&P 500 by 5% (13.1% versus 8.1%).
10-year period, buyout equity underperformed the S&P 500 by 0.2% (15.3% versus 15.5%).
3-year period, buyout equity outperformed the S&P 500 by 1.2% (15.6% versus 14.4%).
While venture capital and buyout private equity may be attractive, the public stock market provides opportunity of its own.
The Distribution of Returns in the Market summarizes a study of 8,000 stocks from 1983 to 2006. The contributors found that over the 23-year period...
35% of stocks had annualized returns greater than 10%.
14% of stocks had annualized returns greater than 20%.
Closing
Investors have many choices for where to invest their money.
Public and private markets offer distinct ways to invest in companies.
All of these have different characteristics. They require distinct skill sets and networks. They allow for different levels of active involvement. They have distinct risks and payouts. They provide different access to liquidity and diversification.
One common thread is that investors can benefit by investing in the best.
It takes work to find and network with the best firms.
It takes work to find and invest in the best companies, be it private or public markets.
When done well, the rewards are worthwhile.
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Torre Financial is an independent investment advisory firm focused on emerging and established compounders.
Federico Torre
Torre Financial
federico@torrefinancial.com
https://torrefinancial.com
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