Difficulties In Private Market Investing

Private markets have become increasingly attractive due to their potentially higher returns compared to public markets. Retail investors may gain exposure to the private markets indirectly through publicly listed mutual funds run by wealth management firms or ETFs tracking the wider PE sector.

However, investing in them directly comes with a unique set of challenges.

Difficult to value

Investors cannot find private equity investments in the public markets. Due to their unlisted status, private companies are not required to abide by certain financial disclosure requirements. Hence there may be a lack of transparency and information required to accurately value the company to determine whether an investment is worthwhile.

There is also a general lack of analyst coverage and due diligence conducted, which makes it even more difficult to select the right investments. As shown in the exhibit below, the average dispersion of returns from first and third quartile PE funds is over 1,900 basis points, which is very substantial compared to other forms of investments.

Only a small handful of companies eventually make significant returns to investors out of the entire private market portfolio. To mitigate these risks, in-depth due diligence is crucial to selecting top-quartile investments.

No visibility on exit

Private equity investments are relatively illiquid due to the lack of a public exchange mechanism to match buyers and sellers. Additionally, there may have liquidation limitations in their investment agreements.

As a result, private market investors usually have to wait for exit opportunities to realise any form of returns. These exit opportunities can exist in the form of an IPO, share buyback or sale of the private company.

But before these opportunities arise, private companies need time to grow their businesses. Private equity investments typically have long investment periods of approximately 10 years or more. It is almost impossible to accurately time the entry and exit into PE investments as performance is dependent of various external factors, such as business cycle and availability of capital flows.

Although investors might be able to access the secondary market for private equities by selling an interest to other private investors, these are generally sold at a discount and not favourable to the seller.

Limited access to deal flow

Private equity investing traditionally belongs to the domain of institutional investors and high net worth individuals through fund structures due to their established scale and relationships. To gain access to private equity funds managed by big names in the industry, your minimum investment required could go from $200,000 to the millions. Management fees are substantially high as well.

On the other hand, seeking access to private companies directly without going through funds would require even higher investment minimums. This represents a high barrier to entry for most retail investors.