Private equity, private debt and other alternative investments: Should you invest?

What are private investments?

“Private investment” is a catch-all term that refers to financial assets that are not traded on public markets, bonds or derivatives. It includes private equity, private debt, private equity pools, venture capital, infrastructure and other strategies (aka hedge funds). Until recently, you had to be an accredited investor, with a net income and a certain level, for an asset manager or third-party advisor to sell you a private investment. On the other hand, private asset managers often demand minimum investment and lock-in periods that prohibit all but the wealthy. But a 2019 law change that allowed for “differently liquid” mutual funds and other innovations in Canada made private equity investments accessible to more investors.

Why do people talk about private property?

The number of investors and the money they have to invest has increased over the years, but the size of the public markets has not. The number of active companies (not including exchange-traded funds, or ETFs) that actually trade on the Toronto Stock Exchange he refused to 712 by the end of 2023 from about 1,200 at the beginning of the millennium. The same has been observed in many developed markets. US enrollment has dropped from 8,000 in the late 1990s to about 4,300 today. Logically that would cause the price of public securities to rise, which it probably did. But something else did, too.

Starting 30 years ago, large investors such as pension funds, international wealth funds and university funds began to allocate money to private investments instead. On the other side of the table, all kinds of investment firms have sprung up to pool and sell private equity investments—for example, private equity firms that work by buying companies from their founders or on the public markets, making them more profitable, and then selling them. seven or 10 years later double or triple the amount. Cash flows to private equity have grown 10-fold since the 2008 global financial crisis.

In the past, companies that needed more capital to grow often had to go public; now, they have the option of staying private, backed by private investors. Many choose to do so, to avoid the burdensome and expensive reporting requirements of public companies and the pressure to please shareholders quarter after quarter. Thus, public companies represent a smaller part of the economy than before.

Increasingly, stocks and bonds have been very well correlated in recent years; in an almost unprecedented event, both asset classes fall in tandem in 2022. Not just pension funds but small investors, too, are now worried that they must gain exposure to private markets or be left behind.

What can private investments do for my portfolio?

There are two main reasons why investors may want private equity investments in their portfolios:

• Benefits of diversity: Private equity investments are considered a different asset class than publicly traded securities. The benefits of private equity investing are not closely related to the stock or bond market. Therefore, they help diversify the portfolio and moderate its ups and downs.
• Top returns: According to Bain & Company, private equity has outperformed public equity over the past three decades. But findings like these are controversial, not just because Bain itself is a private equity firm but because there are no comprehensive indicators that measure the performance of private equity firms—the evidence is mostly anecdotal—and their track record is short. Some academic research has concluded that some or all of the best private equity investments can be attributed to the long-term holding period, which is a proven strategy in almost any asset class. Because of their illegality, investors must hold them for seven years or more (depending on the type of investment).

What are the barriers to private equity investment?

Although the barriers to private equity investment have decreased somewhat, investors still have to contend with:

• lliquidity: Traditional private equity funds require a shorter investment period, typically seven to 12 years. Even “evergreen” funds that continue to reinvest (rather than expire after 10 to 15 years) have restrictions on redemptions, such as how often you can redeem and how much notice you must give.
• Minor regulatory oversight: Private equity funds are exempt from many public securities disclosure requirements. Having brand name property managers can provide some assurance, but they often charge very high fees.
• Short track records: Relatively new asset classes—such as private mortgages and corporate loans—have limited histories and small sample sizes, making due diligence difficult compared to researching the stock and bond markets.
• They may not be eligible for registered accounts: You can't hold certain types of private company shares or general partnership units in a registered retirement savings plan (RRSP), for example.
• High management fees: Another reason why private investment is on the rise: as discount brokerages, index and ETFs lower costs in traditional asset classes, private investment represents a market where the investment industry can still make huge profits. The “two and 20” hedge fund rate—a management fee of 2% of assets per year and 20% of profits above a certain threshold. Even their “liquid alt” cousins ​​in Canada charge 1.25% for management and a 15.7% performance fee on average. So asset managers have an interest in packaging and promoting more private asset offerings.

How can retail investors buy private equity investments?

To invest in traditional private equity funds, you still have to be an accredited investor—meaning in Canada you've had $1 million in financial assets (minus liabilities), $5 million in net worth or $200,000 in pre-tax income for each of the past two years ( $300,000 for a couple). But for investors who use less methods, there is a growing array of workarounds: