Private markets have long been a hidden gem leveraged by high-net-worth investors and institutions. But factors including regulatory shifts, the increasing popularity of crypto and the emergence of thriving privately held tech companies have brought private markets closer to the mainstream.
Within private markets, investors will find an expanded set of opportunities for diversification, returns and risks. A balanced, informed approach is critical to accessing the benefits private market investing can offer. In order to begin building a strong alternatives portfolio, it’s crucial investors understand the key characteristics of the private markets, the kind of investments available and how they can be accessed.
Public vs. Private Markets: Key Differences
Before making the decision to invest in private markets, it’s important to understand how they differ from the public markets you’ve likely had exposure to. The simplest distinction is that public investments like stocks and bonds are traded on exchanges and available to any investor with a brokerage account. Importantly, they are also registered with the Securities Exchange Commission (SEC) and are required to submit public filings such as financial reports. These rules help create accountability and transparency for publicly traded companies. Private market investments, such as private equity, venture capital and private credit, are not listed on public exchanges and are typically accessible only to accredited investors. They are typically not required to register with the SEC, which can mean that the information about these companies available to investors may be limited. There are several other key differentiators between public and private market investments.
Liquidity
- Public markets are highly liquid, meaning most stocks can be bought or sold in seconds, and prices are determined in real time. There is more variation when it comes to bonds, but generally public markets offer greater liquidity than private markets.
- Private markets are typically illiquid. Investment capital is usually committed for years, with no ready secondary market to sell stakes. This underpins the “illiquidity premium” often associated with private market investing. Due to this lack of liquidity, investors expect to be compensated with the potential for higher returns, though such outcomes are not guaranteed and losses are possible.
Valuation & Price Discovery
- Public securities are marked-to-market continuously, meaning the value can fluctuate constantly to reflect the current market. This offers the ability to closely track price changes to inform investment decisions, but can also mean experiencing periods of volatility.
- Private assets are valued periodically (often quarterly) using models, comparables, and management assumptions, which may reduce the appearance of short-term volatility, but can also potentially obscure short-term performance changes and accurate pricing.
Risk & Return Profile
- Public markets tend to have lower expected returns relative to private markets but also lower dispersion between top and bottom performers.
- Private markets have the potential to produce strong returns, but success can be highly dependent on manager skill, deal access, diversification, and timing.
Overview of Major Private Market Segments
Private market investing spans a broad range of asset classes, each with its own risk profile, return potential, and role in a diversified portfolio. As mentioned, these investments are typically illiquid, valued periodically, and have the potential to generate notable returns outside of those commonly seen in public markets. Private market assets may offer unique opportunities for growth, income, and diversification. Below is a breakdown of key and often well-known segments within the private markets, including what they are, how they work, and why investors may consider them.
Private Equity (PE)
- Focuses on acquiring majority control of established, cash-flowing businesses
- Often uses leverage (debt) to amplify returns
- Common investment strategies include buyouts, growth equity and distressed investing
Venture Capital (VC)
- Invests in early-stage or high-growth companies with high risk and high potential upside
- VC portfolios often see many losses offset by a few exceptional winners
Private Credit
- Provides loans directly to businesses outside the traditional banking system
- Strategies include senior secured loans, mezzanine financing and distressed debt
- Returns are often income-oriented, appealing to investors seeking yield
Other Segments
- Real Assets: Private real estate, infrastructure, natural resources.
- Secondaries: Buying existing LP interests in funds at a discount, providing liquidity to early investors.
The Investment Lifecycle in Private Markets
While each asset class within private markets has its nuances, many private investments follow a similar lifecycle from capital raising to exit.
Step 1: Fundraising
A private investment manager (often called the “general partner” or GP), or founder in the case of a startup, raises capital from investors (“limited partners” or LPs). In most cases, LPs commit to provide a certain amount of capital over time, rather than funding the full commitment upfront.
Step 2: Sourcing and Due Diligence
In the case of a private market fund, the GP then identifies opportunities such as buying companies (private equity), funding startups (venture capital) or structuring loans (private credit). This stage involves deep diligence: analyzing financials, interviewing management, assessing competitive advantages and stress-testing assumptions.
Step 3: Capital Calls
Instead of investing all at once, LPs typically receive “capital calls” over the investment period (often the first 3–5 years of a fund’s life). This phased deployment ensures money is only drawn when it’s ready to be put to work.
Step 4: Value Creation and Management
- Private Equity: GPs may improve operations, optimize capital structure or pursue strategic acquisitions.
- Venture Capital: GPs support early-stage companies through introductions, hiring and follow-on financing.
- Private Credit: GPs monitor borrower performance, enforce covenants and work to protect downside.
Step 5: Exit
Exits vary by asset class:
- Private Equity: Selling the company to a strategic buyer, another PE fund or via IPO.
- Venture Capital: IPOs, acquisitions or secondary share sales.
- Private Credit: Return of principal upon loan maturity or sale of the debt.
Step 6: Distribution of Returns
Proceeds from exits or repayments are distributed to LPs, typically after the GP has returned all invested capital and earned any agreed-upon share of profits (the “carried interest”).
Common Private Investment Structures
Understanding structure prior to investing in the private markets is critical as these vehicles determine how you invest, how returns are distributed and what your legal rights are.
Private Market Funds
- Limited Partnership (LP) Model is the most common structure. The LPs provide capital and the GPs manage the investments. GPs typically earn an annual management fee (e.g., 2% of committed capital) and carried interest (often 20% of profits above a set threshold).
- Closed-End Funds have a defined investment and harvest period, usually 7–12 years.
- Interval Funds can offer increased liquidity as the investment company will periodically provide opportunities for investors to sell shares back to the company.
Special Purpose Vehicles (SPVs)
These single-deal entities are set up to invest in one specific opportunity. They are popular in venture capital syndicates and co-investments. SPVs allow investors to target deals without committing to a full blind-pool fund.
Co-Investments
Co-investments offer opportunities for LPs to invest directly alongside a fund’s main investments, often with lower or no fees. They are attractive to investors who want to put more capital into specific deals and reduce blended fees.
Risks, Returns and Other Considerations Before Investing
While private markets offer compelling return potential, they also come with unique risks that investors should carefully consider prior to investing. From illiquidity to leverage, understanding these factors and how to hedge them can help investors build a more resilient portfolio. Below are some of the key risks, potential rewards and a due diligence checklist to guide the evaluation process.
Risks
- Illiquidity: Capital is locked up for years. Hedge by using funds allocated for a longer horizon, such as investing through a self-directed IRA.
- Concentration Risk: Especially in VC, a few holdings may drive most of the return. Hedge by aiming for a basket of 20-25 investments.
- Manager Risk: Performance hinges on the GP’s ability to source and execute deals. Hedge with due diligence on the fund’s historic performance and deals currently in queue when possible.
- Leverage Risk: Common in PE and private credit, leverage magnifies both gains and losses. Similar to concentration risk, hedge by diversifying with other private investments.
Return Potential
Private markets can potentially deliver higher absolute returns. It’s not uncommon for a couple of core successes to offset other losses. Even so, it’s important to keep in mind that with this return potential comes risks that can outweigh those found in public markets.
Due Diligence Checklist
- Track Record: Historical returns, preferably across cycles. Or in the case of a startup, previous valuations and funding rounds.
- Team Stability: Key personnel and alignment of incentives.
- Strategy Fit: Does the GP’s strategy align with your risk tolerance and objectives? Or in the case of a startup, do you resonate with the founder’s vision and plan to achieve it?
- Fee Structure: Understand the management fee, carry and any other costs.
- Liquidity Needs: Can you afford to tie up this portion of capital for 7–10+ years, or sustain a total loss?
Private market investing offers a compelling complement to public market portfolios: potentially higher returns, access to a myriad of opportunities, and additional diversification. While there are important considerations, including illiquidity and the need for increased due diligence, private investments can be an important part of a long-term wealth-building strategy. Through a self-directed IRA, Alto provides investors with a way to allocate retirement funds to private market opportunities. This type of account may offer tax advantages depending on an investor’s individual circumstances, and Alto’s platform is designed to help facilitate access.
