Direct private investments refer to investments made directly into private companies, outside of public markets. This article analyzes returns, risks, accessibility and other key aspects of private investments. With increasing regulation in public markets, direct private investments provide an alternative avenue for higher returns, if risks can be managed properly. We dive deeper into different types of private investments, and how institutional investors or high net worth individuals can gain exposure.
Higher historical returns than public markets
Research shows that private investments, especially private equity, have outperformed public market equivalents over long time horizons. For example, Cambridge Associates’ private equity index returned 13.6% annually from 2006-2020, compared to 8.3% for the S&P 500. This outperformance is attributed to the illiquidity premium, as private assets are harder to buy and sell. Additionally, private investments allow more active value creation through operational improvements.
Lower correlation provides diversification
Private investments demonstrate low to negative correlation with traditional assets like stocks and bonds. This was evident during the 2008 financial crisis when private equity valuations held up better. Thus, adding private investments to a portfolio can provide diversification benefits and lower volatility. However, risks remain higher for standalone private investments given regulatory gaps.
Direct access often limited to institutional investors
Direct private investments are often restricted to institutional investors like pensions, endowments, family offices with large minimums. Retail investors rarely get co-investment rights or direct access. Thus, the adjacent trend is the rise of private market funds to pool capital. But investors should still evaluate manager skill, fees and redemption terms which vary.
Due diligence critical to evaluate opaque assets
Unlike public securities, private investments lack mark-to-market valuations, ratings and research. Investors rely on irregular reporting from managers, needing robust due diligence on track record, strategy, operations, compliance and risk management. Adverse selection bias exists where lower quality assets may be shopped more actively. Thus manager relationships and reference checks grow in importance before committing capital.
In conclusion, direct private investments can enhance portfolio returns given their historical premium over public markets. However, the risks, due diligence requirements, access restrictions also rise in tandem. Weighing these aspects allows investors to make an informed allocation to complement public market holdings.