Private assets

What Are Private Assets?

Private assets refer to investments that are not publicly traded on a stock exchange or other organized financial markets. Unlike publicly listed stocks or bonds, private assets are typically illiquid, meaning they cannot be easily bought or sold. This characteristic often stems from a lack of established trading venues and standardized valuation practices. Private assets fall under the broader category of alternative investments within investment management, offering investors potential diversification benefits and distinct risk-return profiles compared to traditional asset classes.

History and Origin

While various forms of non-public investments have existed for centuries, the modern private asset market, particularly private equity, gained significant traction in the mid-20th century. Early forms included wealthy families investing directly in businesses or initial venture capital funding for nascent companies. A significant milestone was the establishment of American Research and Development Corporation (ARDC) in 1946, considered one of the first publicly funded venture capital firms. Over the past two decades, private markets have experienced substantial growth and consolidation, primarily driven by institutional investors seeking yield and portfolio diversification. Global private capital pools, encompassing private equity, private credit, and real assets, have surged, doubling in size from six years prior to reaching over $12 trillion by December 2021.⁴ The evolution has seen a shift from direct family investments to a landscape dominated by specialized "alternative asset managers" or fund managers, which typically started as private equity or venture capital firms and later expanded into other private strategies like private credit.

Key Takeaways

• Private assets are investments not publicly traded, characterized by illiquidity and typically accessed by sophisticated investors.
• They encompass a broad range, including private equity, private debt, real estate, and infrastructure.
• Historically, private assets have offered potential for higher returns, partly due to an "illiquidity premium" and skill-based value creation.
• Challenges include complex valuation methodologies, limited transparency, and the long-term commitment of capital required.
• They can offer significant portfolio diversification benefits by having lower correlation with public markets.

Interpreting Private Assets

Interpreting private assets involves understanding their unique characteristics and the specific context of the underlying investments. Unlike public assets with daily market prices, private asset valuation is often less frequent and relies on complex methodologies, sometimes leading to "smoothed" returns that may not fully reflect market volatility. Investors assess private assets based on factors like the fund's investment strategy, the manager's track record in due diligence and value creation, and the projected rate of return. Given their illiquidity, a crucial aspect of interpretation is evaluating the investment horizon and the investor's ability to withstand extended periods without access to their capital.

Hypothetical Example

Consider a university endowment fund looking to enhance its portfolio returns. Instead of solely investing in publicly traded stocks and bonds, the endowment decides to allocate a portion of its capital to private assets. They identify a reputable firm specializing in growth-stage technology companies. The endowment commits $75 million to a 10-year private fund. Over the next few years, the firm makes "capital calls," drawing down committed capital as it identifies and invests in private technology companies. The endowment's investment remains locked up during this period. The fund manager actively works with these companies, providing strategic guidance and operational support to foster their growth. After several years, some of these companies achieve successful exits through acquisitions or initial public offerings, generating substantial returns. The endowment receives distributions from these exits, which contribute to its overall investment performance.

Practical Applications

Private assets are integral to the portfolios of many sophisticated investors, particularly large institutional investors like pension funds, endowments, and sovereign wealth funds. These assets are primarily used for:

• Diversification: Offering returns that may have low correlation with traditional public market cycles, thereby enhancing risk management strategies.
• Access to Growth: Providing capital to nascent or privately held companies that may not yet be mature enough for public markets, such as early-stage startups or established businesses undergoing expansion.
• Illiquidity Premium: Seeking additional returns as compensation for the commitment of capital over long periods and the limited liquidity of these investments. While a component of return, research from firms like AQR Capital Management suggests that the illiquidity premium alone may not fully explain historical outperformance.³
• Value Creation: Active management by private asset managers, who often take significant ownership stakes and implement operational improvements or strategic initiatives to increase the value of portfolio companies.

Limitations and Criticisms

Despite their appeal, private assets come with significant limitations and criticisms:

• Illiquidity Risk: The most prominent drawback is their lack of liquidity. Investors' capital is typically locked up for extended periods (e.g., 7-12 years for many private funds), making it difficult to access funds if unforeseen needs arise.
• Valuation Challenges: Private assets are not subject to daily market pricing, making their valuation inherently more subjective and less transparent than public assets. Regulators and investors have increased scrutiny on how these assets are valued, especially given the divergence sometimes observed between public and unlisted equity returns.² Issues like smoothing, staleness, and biases in appraised valuations can obscure the true economic risk.
• High Fees and Costs: Private asset funds often charge higher management fees and carried interest (a share of profits) compared to traditional investment vehicles, which can significantly impact net returns.
• Limited Transparency: Detailed information about underlying private portfolio companies is often less readily available compared to public companies, complicating due diligence and ongoing monitoring for investors.
• Accessibility: Historically, private assets have been largely inaccessible to individual investors, being restricted to accredited investors and large institutions due to regulatory requirements and high minimum investment thresholds. The U.S. Securities and Exchange Commission (SEC) provides exemptions from registration for private offerings under Regulation D, commonly Rule 506(b) and Rule 506(c), which cater to these types of investors.¹

Private Assets vs. Public Assets

The fundamental distinction between private assets and public assets lies in their tradability and regulatory environment.

Confusion often arises because both categories represent forms of investment, but their structural differences lead to vastly different investment characteristics, risks, and required investor profiles. Public assets offer ease of access and price discovery, while private assets promise potential long-term outperformance and diversification in exchange for reduced liquidity and transparency.

FAQs

What types of investments are considered private assets?

Private assets include a wide range of investments such as private equity (e.g., leveraged buyouts, growth capital), venture capital, private debt (e.g., direct lending), real estate (non-publicly traded properties or funds), and infrastructure projects.

Why do investors choose private assets over public assets?

Investors often choose private assets for potential portfolio diversification, the opportunity to earn an illiquidity premium, and access to unique growth opportunities not available in public markets. They also seek the active value creation strategies employed by private asset managers.

Are private assets only for wealthy investors?

Historically, access to private assets has been largely restricted to large institutional investors and high-net-worth individuals who meet the criteria of an accredited investor. However, new fund structures are emerging that aim to make some private asset categories more accessible to a broader range of investors, though minimums remain higher than public market investments.

What are the main risks associated with private assets?

Key risks include their illiquidity, meaning capital is locked up for long periods; complex and less transparent valuation processes; and the potential for higher fees. Additionally, the performance of private assets can be highly dependent on the skill of the fund manager.