Why Private Markets Usually Outperform Public Markets

Why Private Markets Usually Outperform Public Markets

We live in a chaotic era in which global change appears to occur faster than anyone has time to adjust to previous changes. We have seen human behaviour, consumption, and work patterns completely transform after two years of a global pandemic and another year attempting to adjust to its aftermath. Many companies have decided to work entirely remotely, and we still see large swaths of the population who are hesitant to return to work because they have relocated to more affordable areas in order to maximise their ability to work from home. Changes are also taking place in the world of investing. Private equity investments are becoming more popular among the mass affluent, having previously been restricted to a few investor categories, primarily institutional investors, and ultra-high net worth individuals. Private equity is not for everyone because it necessitates some level of financial knowledge as an informed investor. However, among investors who take the time to educate themselves, there is a growing understanding. Markets have been unpredictable and volatile in recent times, with some changes being unprecedented as a result of global events. In a time of great change, the only certainty appears to be that nothing is certain.

Transformational change, on the other hand, does not have to be a source of concern; it can sometimes be a catalyst for innovation, leading to new opportunities for long-term investors willing to shift with change. So, too, is the growing interest in private markets, given the opportunities it provides for investors to gain access to exclusive deals with the potential to outperform inflation and provide excellent long-term wealth creation. The advancement of technology and the modernization of regulations have greatly aided in making such investments accessible to a larger population. In this article we will discuss what makes such investments attractive over public market opportunities.

What is Private Equity?

Private equity refers to ownership or interest in a company that is not publicly traded or listed. Private equity is a type of investment capital that comes from high-net-worth individuals and firms that buy stakes in private companies or take control.

Institutional investors, such as pension funds, and large private equity firms funded by accredited investors make up the private equity industry. Because private equity requires direct investment—often to gain influence or control over a company's operations—a substantial capital outlay is required, which is why funds with deep pockets dominate the industry. However, there are disruptors to these and some new age PE funds, real estate investment funds are offering similar opportunities to the mass affluent informed investors.

Illiquidity:

Because there are no public markets, the private market can be illiquid. However, certain opportunities, such as real estate, can benefit from efficient secondary markets. In the United Kingdom, one good example is the buy-to-let sector, which is undersupplied and always in high demand, and is popular with private markets. If you invest in buy-to-let rental property, that property will always be valuable because it provides housing, and new households will always form. In contrast, more liquid asset classes, such as the stock market, are much more vulnerable to sudden depreciation in value. Consider the 1929 Wall Street crash as an example of how hedging your bets on liquid assets can have disastrous consequences for the value of your investments. Similarly, if you own stock in a public company and the other shareholders decide to sell their stock suddenly, the value of your stock will plummet, forcing you to sell at an inconvenient time. Private equity, on the other hand, operates in a very different manner. A small group of decision makers has the authority to decide when it is best to sell. These decision makers would be highly qualified professionals with market analysis expertise who understand when the best time to sell is. This means that, rather than relying on the actions of others to determine when and when not to sell, your investment capital will be managed by trained professionals who understand what is best for your money. It’s like a private club where individuals with similar investment thesis comes together to make the most of their investments.

Here are a few reasons that adds to the popularity of PE Investments

1. Private Equity Performance Follows Recessionary Trends - PitchBook examined historical data to see how buyout funds specifically reacted during previous crises, such as the Tech Bubble, 9/11, and the Global Financial Crisis (GFC), and concluded that private equity performance tends to follow recessionary periods.

2. Private equity does not typically rise and fall with stock markets - Stock market investments are typically linked to overall market volatility and fluctuations. Large-scale market trends are frequently triggered by global and domestic economic events. One advantage of private equity investments is that they are less affected by current economic and market trends. Private equity investments are valued based on company metrics and performance. They are unaffected by market fluctuations.

3. Can protect against downside - Adding private equity investments to a portfolio that includes publicly traded investments can help to improve risk management. Data suggests that during recessions, majority almost two thirds of publicly traded equities have suffered great losses, as much as a fall of 70% or more from their peak values. However, only about a couple of every hundred private equity funds have suffered a similar loss.

4. Higher returns - Private equity has historically outperformed publicly traded equities. Consider being able to invest in Tesla before it went public.

5. It can be a great way to supplement your income and beat inflation in the long term.

Overview for PE Investments

The private market has historically outperformed the public market by a wide margin. Even though there are fees and profit-sharing strategies in a private market, the potential returns outweigh this difference. The professionals work for their own profits which are a part of your profits. One must look for opportunities where all parties' interests, including the PE managers, are aligned. PE isn't exactly available in base retail denominations, which means that while you'll have to put up a little more money up front, the return on your investment will be sufficient to make it worthwhile.

Furthermore, the private market has a demonstrated track record of being a far more secure investment. According to Hamilton Lane, developed market buyout and private credit have never had negative returns over any five-year period between 1995 and 2020.

The private market outperforms the public market due to its extensive resources and valuation tools available to influence the value of an investment.

This includes the following:

  1. Acquisition- The general partners of a private equity firm can generate new investment opportunities for you to choose from, leveraging the investment's size, industry expertise, and complexity. This is not possible in a more open market where such information may be controlled by an external body. They can also negotiate optimised agreements to ensure that your investment generates the highest possible returns by utilising privileged material and information that is not available to all.
  2. Business Transformation- Private equity owners have the option of implementing operational improvements to benefit their shareholders. This includes cost-cutting and talent enhancements, as well as strategic initiatives such as acquisitions and product launches.
  3. Exit Options- Private equity investments are long-term investments with a variety of exit options at the point of maximum value. These include initial public offerings (IPOs), strategic buyouts, and private equity sponsors.

These factors do not always imply higher returns. Indeed, though it is uncommon, there have been times when the public market outperformed the private one. However, with skilled and qualified management ensuring that your investments are properly capitalised on, you can be certain of receiving higher returns than you could have hoped for in the public market.

To summarise, there are numerous reasons why the private market has historically outperformed the public one. One such reason is the illiquidity of the type of stock that the private market deals in, which makes it that little bit less risky, which in turn adds confidence to investors, who may now look to investments they would not have considered before and thus pursue those higher returns. The higher potential for returns that the private market enjoys makes taking that risk more appealing. And the sheer number of tools available to private market investors and the general partners of the firms that manage the investments. For decades, these factors have allowed the private market to weather storms without having a significant impact on the overall market. In light of this, we believe that the private market will continue to outperform the public one.

About Us

Novyy is a Community Investing Platform that enables individuals to invest in UK Buy-To-Let, Leading Real Estate Private Equity Funds, and Premium Homes across Europe with as little as £10,000. Novyy users enjoy seamless digital investing like never before, in opportunities that were earlier unavailable to most individuals. This piece should not be construed as tax advice. Please refer to your tax advisor before making any decisions on owning properties through Limited Companies.