Investing in private markets can net big benefits over public markets. Read on to learn the difference between the two, and what private investing can offer.
The core difference between private markets and public markets is in how market participants, both buyers and sellers, access the market to invest and to raise capital.
For example, the public equities market — like the FTSE-100 or S&P 500 — companies raise money (‘capital’) by selling stock. This is also known as equity or shares. These shares represent an ownership interest in the company.
As this is a ‘public’ market, anyone can purchase shares in a company which is listed on the market. Companies can only enter the market to raise capital when they have satisfied a range of criteria set by the market regulator. They must then continue to disclose information to remain a listed or ‘public’ company. Public markets are described as ‘liquid’ markets, as there is an open marketplace for shareholders to dispose of, or sell, their shares, at their own discretion when desired.
In the private market, by contrast, there is no rigid guidance as to what a company needs to provide in order to acquire finance or what information it must then disclose publicly on an ongoing basis. It can choose who it accepts finance from and on what terms. As the private markets are ‘illiquid’ (shares cannot be freely acquired and sold on an open market), investors in companies on private markets expect higher returns in exchange for this illiquidity. In this article, we’ll explore the two types of market in more detail and outline the benefits of investing in the private market.
What is the Private Market?
The private market is the home of private equity and private debt. Due to the historic performance of these asset classes, the markets have grown exponentially. Increasing numbers of investors are attracted by the opportunity to target returns which can be superior to those available on public markets. Others are interested in the diversification which can be achieved by introducing alternative investments, such as private equity and private debt, into an investment portfolio.
Historically, making an investment in a private market transaction has been restricted to larger, institutional, professional investors, who are capable of injecting large quantums of capital into a transaction. This is more efficient than an investee company dealing with hundreds or thousands of underlying investors. Professional investors also provide ‘patient capital’, which means they recognise the illiquidity inherent in the asset class and are accepting of the long-term nature of investments in order to deliver results and generate investment returns.
These professional private equity investors include:
- Pensions and hedge funds
- Sovereign wealth funds
- Insurance companies
- University endowments
- Family offices
Entry to private market transactions and private market funds is out of reach for many individual, private investors due to prohibitive minimum ticket sizes. But, in recent years, businesses like Connection Capital have created access for private individuals through lower minimum ticket sizes by syndicating an investment. For example, we can provide private companies with up to £12m — and our clients can invest from just £25k.
What is private equity?
Private equity is defined as capital investment into businesses and companies that are not on the public market. Investors buy a stake in the value of a private company in the hope that their stake will increase in value.
Key forms of private equity purchase include venture capital, growth equity, and buyouts.
Venture capital refers to early-stage investments, whereby venture capitalists put money into new and growing companies to help them achieve success. This can involve some uncertainty, as the companies are, by nature, unproven. But the returns have the potential to be sizeable.
Growth equity refers to investment in more established and more mature companies that are seeking to grow to a new stage. This could be by acquiring competitors or complementary businesses or by expanding internationally.
Buyouts are when existing investors cash out and the purchasers take over a meaningful share of the company.
Are Private Markets Bigger Than Public Markets?
Public markets are much larger than private markets. Global equity markets’ value was estimated at $124 trillion for 2021 versus $10 trillion for private markets, according to SIFMA and McKinsey. But private markets have been growing in size — and at a faster rate than public markets — as alternative assets have demonstrated outperformance of traditional ones, and as new asset classes emerge and evolve.
McKinsey’s Private Markets Annual Review for 2021 showed how private markets reached record highs across multiple metrics:
- Fundraising increased by nearly 20% to a high of almost $1.2 trillion
- The total value of deals across all asset classes hit $3.5 trillion
There is clear momentum in private markets, with Preqin estimating assets under management to more than double to $24 trillion in 2026. This relentless growth will be driven by both the unique benefits that investing in private markets can provide investors, and the fact that companies are staying private for longer and no longer need to rely on public markets to finance their growth.
Benefits of Investing in Private Markets
There are many reasons an investor may choose to invest in private markets. As with all investments, the core trade off is between risk and reward. As discussed above, private markets are often less liquid than public markets. Investors should understand and be comfortable with all facets associated with any investment, and that goes for a private market investment too.
One of the most compelling reasons is that investments in private markets can potentially yield superior returns to the public markets. The BVCA has released research showing UK private equity and venture capital funds outperform the FTSE 100 and FTSE All Share over one, three, five and 10 years.
Another core reason is the diversification that private markets can provide from public markets due to the differing sources of risk and return, which are less correlated with those affecting public markets. As investors are aware, introducing diversification can help to smooth overall portfolio volatility.
The illiquidity premium
The illiquidity premium is the name given to the benefit that investors expect to receive in exchange for reduced liquidity. Investors need an incentive to take positions that are harder to change. The illiquidity premium provides this incentive, by suggesting that illiquid assets can generate higher rates than liquid ones (although this isn’t guaranteed).
Correlation is not necessarily causation, though. One of the reasons illiquid private market investments outperform public markets is not because they are illiquid, but because many illiquid alternative investment types have more attractive risk-reward profiles than liquid investments.
Lengthier investment periods more naturally suit private market focused investment strategies — such as venture and private equity — which are complex and require time for active investors to enact their growth plans for a company.
Private market performance is not correlated with public
Private market investments are valued much less frequently than public market investments. As a result, daily news — good or bad — and the volatility it creates on public markets affects private markets less. And, as illiquidity means investors are in it for the medium to long term, there is no possibility of valuations being dragged lower by the herd mentality which can cause stocks to plummet in value overnight. This is because public-market investors typically cash out en masse as soon as stocks start to decline in value.
This means that private markets are not (or at least, less) correlated with public markets and are insulated from the volatility experienced by listed equities and bonds on the back of a market ‘shock’. The global financial crisis (GFC) in 2008 and the war in Ukraine are both examples of this.
If you can afford to put your cash away for the medium to long term and clearly understand the high risks, then private market investments can help you target significant returns and improve diversification — which is even more important if the public markets are crashing.
Portfolio diversification aims to reduce the volatility of investment returns through exposure to a wide range of sources of risk and return. Traditional investment portfolios have typically done this through public market investments, including stocks, bonds and cash. However, with fixed income investments underperforming over the past decade and, in 2022, displaying high correlation with equities, a growing number of investors are increasing their portfolio allocation to alternative, private market assets.
The intention is to reduce volatility by seeking improved diversification and to target the enhanced return potential of private market investments.
Is Private Investment Better Than Public Investment?
The most appropriate answer is that a mix of asset classes is the best way to construct a portfolio to optimise diversification. Conceptually, this includes both private market and public market assets. In reality, investors need to be comfortable with all the features of the individual asset classes and investment strategies they allocate to. When it comes to private market investments it means understanding and tolerating the inherent illiquidity and the high risks involved.
For experienced investors, with the patience to invest for the medium to long-term, this is a small price to pay to target enhanced risk adjusted returns and reduce overall portfolio volatility.
We hope this article has helped you to understand the core distinctions between public and private markets. If you’re interested in exploring private markets further, please contact our team and we’d be happy to help explore your options.
Past performance is not a reliable indicator of future performance. Investments in private investments/markets are high risk and speculative which means there is no guarantee of returns and investors should not invest unless they are prepared to lose all of their money. This type of investment is illiquid so can’t be easily accessed until the exit point. The investor is unlikely to be protected if something goes wrong.