Investing in stocks (public equity) or private equity can be a daunting task, especially for beginners.
Both types of investments have their own advantages and disadvantages, and investors should carefully consider their goals and risk tolerance before investing in either.
Key Takeaways – Stocks vs. Private Equity
- Public equity offers liquidity, transparency, and easy diversification, but the stock market can be volatile and some products may come with high fees (in addition to transaction costs).
- Private equity can offer higher returns and direct involvement in company management, but also comes with illiquidity, high fees, and lack of transparency.
- The decision to invest in public equity or private assets (and to what extent) depends on individual goals, risk tolerance, and access to specialized knowledge or relationships, and should be made after careful research and consultation with a financial advisor.
Public equity refers to shares of stock in companies that are traded on public stock exchanges, such as the New York Stock Exchange or Nasdaq.
Anyone can buy or sell these stocks, and they offer investors an opportunity to participate in the ownership and growth of some of the world’s most successful companies.
One of the key advantages of public equity is its liquidity.
Since these stocks are traded on public exchanges, investors can buy or sell them easily, and the prices are transparent.
This means that investors can quickly adjust their holdings in response to changes in market conditions or their own goals.
Another advantage of public equity is that it offers diversification.
Investors can spread their money across different companies, sectors, and countries, reducing the risk of any one investment having an outsized impact on their portfolio.
However, there are also some disadvantages to investing in public equity.
For one, the stock market can be volatile, with prices fluctuating wildly in response to news, economic data, or even social media posts.
This can make it difficult for investors to stay disciplined and focused on their long-term goals.
In addition, there can be high fees associated with investing in public equity, particularly if investors work with financial advisors or invest in mutual funds or exchange-traded funds (ETFs).
These fees can eat into returns over time, making it more difficult to achieve long-term investment goals.
Private assets or private equity, on the other hand, refers to investments in privately held companies that are not traded on public stock exchanges.
Private equity investments are typically made by high-net-worth individuals, institutions, or specialized investment firms, and they offer investors the opportunity to participate in the growth and success of companies that are not accessible to the general public.
Potential for higher returns
One of the key advantages of private equity is that it offers the potential for high returns.
Because these investments are not publicly traded, they are often less liquid and more difficult to value, which can create opportunities for savvy investors who have access to specialized knowledge or relationships.
Private equity investors can also often have more direct involvement in the management of the companies they invest in, which can help to unlock value and drive growth.
Some opportunities are more niche, which limits the capacity but enables for higher returns.
However, there are also some disadvantages to investing in private equity.
The obvious is that these investments are often illiquid, meaning that investors may have to hold them for many years before realizing a return.
This lack of liquidity can also make it difficult to adjust holdings in response to changes in market conditions or investment goals.
In addition, private equity investments can be risky and complex, with high fees and a lack of transparency.
Unlike public equity, which is regulated and subject to disclosure requirements, private equity is often the opposite, with investors having limited access to information about the companies they’re investing in.
The illiquidity premium is a term used to describe the extra return that investors demand for holding investments that are less liquid than others.
Essentially, it’s the compensation investors receive for accepting the lack of flexibility that comes with investing in illiquid assets such as private equity.
Private equity investments typically require a longer-term commitment, often ranging from five to ten years or more.
Bad economic environments can also push out the timeframe until a “liquidity event” can be realized (e.g., selling, going public to liquidate shares).
Accordingly, this lack of liquidity means that investors can’t easily buy or sell their holdings, and they may have to hold their investments for an extended period before they can realize any returns.
However, the illiquidity premium that comes with private equity investments can be a compelling reason for some investors to choose them over more liquid alternatives.
This premium can offer the potential for higher returns than those available in the public markets, as investors are rewarded for accepting the lack of flexibility that comes with illiquid investments.
The main idea is that investors should be expected to demand extra compensation for holding a less liquid investment.
In addition, private equity investments may offer a diversification benefit, as they are often less correlated with the broader stock and bond markets.
This can help to reduce overall portfolio risk and increase the potential for long-term returns.
Overall, the decision to invest in private equity will depend on a variety of factors, including an investor’s risk tolerance, investment goals, and access to certain know-how (to make the investments a success) and relationships.
However, for those willing to accept the lack of flexibility that comes with illiquid investments, the illiquidity premium associated with private equity can make it an attractive choice.
We covered the five main requirements for investing in private assets in this article.
Private Assets Can “Hide” Accounting Volatility
During market downturns, the value of publicly traded assets typically declines rapidly as investors sell off their holdings.
In liquid markets, bid and ask price have to match by definition.
However, the situation is different for private assets, such as real estate, private equity, and other alternative investments.
These assets are often valued less frequently than publicly traded securities, and they are typically less liquid, meaning they are more difficult to sell quickly.
One consequence of these characteristics is that private assets often do not experience the same level of price declines as public assets during market downturns.
As a result, there is a reluctance among private asset managers to accept that the old prices are no longer valid, and they may be hesitant to mark down their assets to reflect the new market realities.
As a result, this can lead to a standoff between buyers and sellers.
Buyers may be willing to purchase private assets at a lower price, but sellers may be unwilling to accept that their assets have lost value, leading to a situation in which transaction volumes decline.
The worse the decline, generally the worse the dry-up in transaction volumes is.
Accordingly, when buyers and sellers can’t agree on prices, this can exacerbate the illiquidity of private assets, leaving investors with fewer opportunities to sell their holdings.
Another factor that can contribute to the reluctance to mark down private assets during market downturns is the pressure that investment managers face to report good performance numbers.
Investors typically evaluate private asset managers based on their track records, and managers may be reluctant to report poor performance numbers resulting from asset write-downs.
This creates a conflict of interest between the need for accurate valuations and the desire to present a positive image to investors.
Stocks or Private Assets?
There is no one-size-fits-all answer to the question of whether public equity or private equity is the right investment for you.
It depends on your investment goals, risk tolerance, knowledge, and relationships.
For investors who are looking for liquidity, diversification, and transparency, public equity may be the better choice.
However, for those who have a certain skill set (process-related) or information edge to take advantage of them, private markets can be a good fit.
After all, most business takes place via private companies and more than 99% of all companies (by quantity, not by market capitalization) are private.
Bigger investors also have access to good managers to take advantage of the illiquidity premium.
On the other hand, for smaller investors who may not have access to specialized knowledge or relationships, private assets may not be the best choice.
If they do, they may be put into products that have high fees and have no advantage relative to those in public markets.
For example, consider the controversy associated with Blackstone’s BREIT product, which has high fees and its poor returns during market downturns are hidden by the fact that it’s not marked to market like public REITs.
It’s important to do your research and please consult with a qualified financial advisor before making any investment decisions.
What REALLY is Private Equity? What do Private Equity Firms ACTUALLY do?
FAQs – Public Equity vs. Private Assets
Who invests in private equity?
Private equity investments are typically made by high-net-worth individuals, institutional investors such as pension funds and endowments, and specialized investment firms.
What is the minimum investment for private equity?
The minimum investment for private equity can vary depending on the investment firm and the specific fund.
However, it’s not uncommon for minimum investments to be in the six or seven-figure range.
Those putting their money into private equity generally have to be accredited investors.
How do investors make money from private equity?
Investors in private equity typically make money through a combination of:
- capital appreciation (i.e., the increase in the value of the investment over time) and
- distributions (i.e., cash payments made by the investment firm from the profits generated by the underlying companies)
What are the risks associated with private equity investments?
Private equity investments can be risky and complex, with a lack of transparency and limited liquidity.
Investors may also face significant fees and expenses, and there is no guarantee of a return on investment.
How do private equity investments differ from public equity investments?
Private equity investments are made in privately held companies that are not traded on public stock exchanges, while public equity investments are made in publicly traded companies.
Private equity investments are typically illiquid and require a longer investment horizon, while public equity investments offer liquidity and can be bought and sold easily.
Can individual investors invest in private equity?
While individual investors can technically invest in private equity, it can be difficult to do so due to high minimum investment requirements and limited access.
How do private equity investments fit into a diversified investment portfolio?
Private equity investments can offer the potential for high returns and diversification benefits, but they should be approached with caution due to the risks and complexities involved.
Investors should consult with a financial advisor before investing in private equity (or any asset or asset class), and should consider their overall investment goals and risk tolerance before making any investment decisions.
Are private assets safer than publicly traded assets?
Due to the mark-to-market accounting of publicly traded assets, it may appear that way, though that doesn’t make them riskier in reality.
The reluctance to mark down private assets during market downturns can have significant consequences for investors.
It can make the illiquidity worse and create a standoff between buyers and sellers, leading to reduced transaction volumes.
It can also result in inaccurate valuations that do not reflect market realities, which can lead to distorted perceptions of returns.
Therefore, even when it’s not in their interests to do so, it can be prudent for private asset managers to be willing to accept and report accurate valuations in order to ensure transparency and provide investors with accurate information about their investments.
Both public equity and private equity have their own advantages and disadvantages.
While public equity offers liquidity, diversification, and transparency, private equity offers the potential for high returns and direct involvement in the management of companies.
Investors should carefully consider their goals and risk tolerance before investing in either, and should seek the advice of a qualified financial professional if necessary.