Investing in Private Equity

Over the years, the number of publicly listed companies on US stock exchanges has decreased dramatically:

Number of Publicly Listed Companies

More companies are delaying going public, meaning a significant part of the economy is difficult for the average investor to include in their portfolio.

We recently gained access to this asset class through a mutual fund. In the past, only large institutional or wealthy investors could gain access to investments in non-public companies. Besides that, there were many other disadvantages to investing in private equity, including the potential for capital calls where the fund managers require that investors provide more capital if needed, high costs including a fee structure like hedge funds (2% management fee and 20% of the gain goes to the manager, typically called 2 and 20) and lock-up periods that prevent access to your investment for potentially several years. Using mutual funds eliminates most of those issues.

Studies regarding private equity performance suggest that the asset class may outperform the S&P 500 by 3% or more per year, a significant amount.

Most investors who invest in private equity must be “qualified” investors as defined by the SEC as someone who has joint income over $300,000 per year for at least two years ($200,000 for a single person) or a net worth of over $1,000,000. This allows them to invest in non-registered investments, i.e., investments that d not need to be registered with the SEC. This requirement made it difficult for most to invest in this asset class.

Private equity investments go through stages:

  1. Pre-seed Funding is typically the founder’s own money, they have a new product, but they may change to a different product or service quickly.
  2. Seed Funding may come from ‘Angel Investors[1]” at this point; they may have a product that is starting to gain traction with consumers.
  3. Early-Stage investment, here they may get funding from an investment capital firm, now the firm has a product that is proven to have a market.
  4. Later Stage, The company has proven itself, but it is not ready to go public yet; think SpaceX; this is the stage at which the vehicle we use invests in the company. In many cases, the company is a market disrupter, upsetting an entire industry just as SpaceX has.
  5. Going Public; the company launches an Initial Public Offering (IPO) and sells shares on the market. It is now a public company. The fund we use can benefit enormously at this stage.

The fund we use has exhibited a lack of correlation with the market and reduced volatility. We are always cautious with this asset class since risks may not be readily identified. We think the potential reward outweighs the risks.

In the video accompanying this blog, we interview Christian Munofo, Chief Investment Officer of Liberty Street Advisors, LLC. He is the lead Portfolio Manager of the Private Shares Fund (PIIVX).

[1] Private Investors.