Investors participate in private capital markets for two main reasons: to pursue increased investment return and to add portfolio diversification.
Even well-informed investors who are experienced in publicly traded equities can be uncertain about private market investing. In addition to possessing good public markets knowledge and expertise, they often need an effective resource to help them respond to questions from others involved in the investment process.
This blog is the first in a series that focuses on the fundamental principles of private capital investing and the key steps to building and maintaining a well-structured private capital program.
Key Steps to Success in Private Capital Investing
The ﬁrst step of successful private capital investing is to learn what private capital is, what its risks and rewards are, and how it differs from public market investing.
Building a private capital allocation that makes a difference to your portfolio takes time and dedication. The ﬁrst step is deciding to make a meaningful allocation to private capital. Then, to implement that allocation prudently, you will need to diversify among several types of private capital investments. Finally, the simultaneous inflows and out- flows of capital over the private capital investment cycle mean that you will need to overcommit funds within your liquidity budget to reach your policy allocation.
Having determined the size of your private capital allocation, you will then want to determine the structure of the portfolio. Private capital investing can take the form of direct investment in private companies, investment in funds organized by private capital managers or investment in a fund of multiple private capital managers (such as a fund of funds or a separate account). There are pros and cons to each approach.
A strong private capital program requires consistent, diversiﬁed investing over time. It is also necessary to have— or obtain externally— resources for research and due diligence before you invest; ongoing monitoring afterward; and useful, reliable internal reporting to ensure appropriate controls.
Private capital investors use a particular set of quantitative and qualitative measures to assess performance. For example, investors often ask about the difference between time-weighted return (“TWR”) and internal rate of return (“IRR”). In general, TWR is used by the investment industry to measure the performance of funds investing in publicly traded securities. By contrast, IRR is normally used to gauge the return of funds that invest in illiquid, non-marketable assets—such as buyout, venture or real estate funds. Find out more about how to calculate these measures here.
While the standard benchmarks used for marketable securities are sometimes applied to private investments, they have limited value. And, as in other investment ﬁelds, historical results tell only part of the story.