Investing in Private Assets – 5 Requirements
Investing in private assets has become increasingly popular among sophisticated investors looking to diversify their portfolios and potentially achieve higher returns.
Private assets refer to investments in assets that are not traded on public exchanges, such as private equity, hedge funds, real estate, and other alternative investments.
However, investing in private assets requires certain requirements and considerations that will differ from traditional, liquid, public investments.
In this article, we’ll discuss the five key requirements for investing in private assets.
Understanding these requirements can help investors make informed decisions and potentially achieve their investment objectives in private markets.
Key Takeaways – Investing in Private Assets
- Investing in private assets requires expertise, time, risk tolerance, income independence, and size.
- Private assets can potentially generate higher returns but come with significant risks, including illiquidity and fluctuations in value.
- Investors must carefully evaluate their circumstances and requirements and seek professional advice before investing in private assets.
#1 Expertise
Expertise is an essential requirement for investing in private assets.
Private assets, by their nature, are not publicly traded, and information about them can be limited or difficult to obtain.
This lack of transparency can make it challenging for investors to make informed investment decisions without a deep understanding of the market, the specific asset class or asset type, and any managers who might oversee the investment.
Many require certain levels of knowledge in order to get the desired result.
Investors must be knowledgeable about the unique features of each asset class, and understand the underlying strategies and risks of the investment.
When applicable, they must also be familiar with the fees charged by managers, which can significantly impact investment returns, and be able to evaluate the performance of these funds and assets.
Additionally, expertise in valuing private assets is important. Private assets can be challenging to value due to their illiquid nature and lack of market data.
Investors must have the skills to analyze financial statements and evaluate the underlying assets of private companies or real estate properties to determine their true value to some level of accuracy.
Overall, expertise is essential for investing in private assets because it enables investors to make better decisions and assess the risks and potential returns associated with each investment.
Without expertise, investors may be unable to identify good investment opportunities or may make poor investment decisions, leading to bad outcomes.
#2 Time
Time is an essential requirement for investing in private assets.
Private assets are typically illiquid and have long lock-up periods, which means that investors must be willing to commit their capital for an extended period.
Unlike public markets, where investors can buy and sell assets quickly, private assets may require a holding period of several years or even a decade or more before they can be sold.
This may be due to actual lock-up periods by private asset managers, or simply due to the reality of an investment. (For example, building a commercial real estate project from scratch and getting it to the point where it matures and is cash flow positive will generally take many years.)
And private assets are often illiquid, which means that investors may not be able to sell their investments when they want to.
Unlike public markets, where investors can buy and sell assets quickly, private assets may require a holding period of several years or even a decade or more before they can be sold.
This can make it difficult for investors who may need their capital back in the short term, or who want the flexibility of being able to change their minds.
If time or flexibility is an issue, then liquid, public markets may be a better fit.
#3 Risk tolerance
Risk tolerance is another critical requirement for investing in private assets.
Private assets, by their nature, are often riskier than traditional investments, such as stocks and bonds, as they often lack liquidity, transparency, and may not be able to be sold easily.
As a result, investing in private assets requires a higher risk tolerance.
This is generally referred to as an illiquidity premium.
Investors who are considering investing in private assets must be aware of the risks associated with these investments, including the possibility of losing a significant portion or even all of their investment.
Unlike publicly traded securities, there may be limited or no secondary markets for these investments, which means that investors may not be able to sell their investment at all or only at a significant discount to its true value.
Investors who are unable to tolerate the risk associated with private assets may be better suited to traditional investments, such as stocks and bonds.
#4 Income independent of your private portfolio
Income independence is another crucial requirement for investing in private assets.
As mentioned, private assets are typically illiquid and require a long-term investment horizon, which means that investors may not have access to their capital for several years or even a decade-plus.
So, ideally, investors should have sufficient income independent of their portfolio to meet their short-term financial needs and expenses.
Investors who rely on their portfolio for income may be forced to sell their private assets prematurely, which can result in significant losses.
For example, if an investor needs to generate income to cover their expenses and relies solely on their private asset investment to do so, they may be forced to sell their investment at an inopportune time, such as during a market downturn, to generate cash.
This can result in significant losses and may erode the potential long-term benefits of the investment.
Having income independent of a private-asset portfolio allows investors to weather short-term financial needs without having to sell their private assets prematurely.
This means that investors can hold onto their investment for the long term, allowing it to mature, develop, and take the long view, which can potentially generate higher returns.
#5 Size
Size is another important requirement for investing in private assets.
Private assets, by their nature, are typically available only to institutional investors or high-net-worth individuals due to high minimum investment requirements.
Investing in private assets often requires a significant amount of capital, which can limit access to the best private fund managers.
Even for small investors looking into things they’ll manage themselves – e.g., residential rental properties – this still requires a large capital commitment in most cases.
Having a significant investment size allows investors to gain privileged access to the best private fund managers and potentially obtain fee discounts.
For example, let’s say a hedge fund has a $5 million investment minimum, a minimum lockup period of 2 years, and charges 2% management fees and a 20% performance fee.
An institution or high-net-worth individual could potentially up the investment beyond the minimum and/or agree to a longer lockup period (if they have a longer time horizon) to get discounted fees.
Alternative managers are often willing to oblige for such large, steady clients.
In turn, this results in more of the investment returns going to them.
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FAQs – Investing in Private Assets
How does it take private equity to provide returns?
It depends. Generally, private assets are often long-term investments that require time to generate returns.
Many private assets, such as private equity, infrastructure, venture, or real estate, require time to mature and develop before they can be sold or generate income.
This means that investors must be willing to wait for their investment to generate returns, which may take several years or even a decade or more.
Is it good to have all of your portfolio in private assets?
Having other income outside of whatever is generated from a private asset portfolio is generally prudent.
This allows investors to meet their short-term financial needs without having to sell their investments prematurely.
Investors should ideally have sufficient income from sources outside their private-asset portfolio to meet their expenses and not rely on it solely to generate income.
Why is it an advantage to be high-net-worth when it comes to investing in private assets?
Private fund managers often have high minimum investment requirements, and they may only accept a limited number of investors.
By having a significant investment size, investors can meet these minimum requirements and potentially negotiate lower fees due to their larger investment size.
Nonetheless, investing in private assets comes with significant risks.
Valuations and liquidity can shrink and it can mean waiting years or decades to realize returns on an investment.
Therefore, investors should not invest more than they can afford to lose in private assets.
Conclusion
Investing in private assets can be a valuable way to diversify a portfolio and potentially achieve higher returns.
However, investing in private assets requires specific requirements and considerations that differ from traditional investments.
Expertise is essential for understanding the unique features of each asset class, analyzing the risks and potential returns associated with each investment, and valuing private assets accurately.
Time is crucial for allowing investments to generate long-term returns and weathering short-term fluctuations in value.
Risk tolerance is necessary for tolerating the higher levels of risk associated with private assets.
Income independence (i.e., income outside that generated by private assets) is crucial for meeting short-term financial needs without having to sell private assets prematurely.
Size is generally essential for gaining privileged access to the world’s best private fund managers and potentially obtaining fee discounts.
Investors who meet these requirements and understand the risks and potential returns associated with private assets can potentially benefit from the long-term advantages of these investments.
However, it is important to invest within their comfort zone and not invest more than they can afford to lose in private assets.