Private Market Investing Requires an Active Approach
Private market investments are not passive investments. Because of how disruption and innovation affect our economy, active management of private market investments by advisors and family offices is critical to identify the innovative companies taking advantage of the opportunities caused by broad economic, environmental and social changes.
Disruptions create opportunities by driving innovation, causing economic realignments and changing the way people live, work and consume products and services. The adoption of automation technologies and faster computer processors have helped many businesses reduce costs and increase efficiency and has led to the revolution in artificial intelligence. Likewise, the COVID-19 pandemic led to a surge in demand for online services, remote-work technologies and an increase in e-commerce.
Short-term economic disruptions typically have a limited and temporary effect on the economy, usually lasting for a few quarters or up to a year. Conversely, long-term economic disruptions can last for several years — or even decades — and can have a profound effect on various industries, leading to significant structural changes in the economy. The companies that are developing the most innovative solutions to these changes are primarily still private and not widely known.
Active management of private investments is key to identifying, and capitalizing on, the emerging trends, industries and technologies that will likely benefit the most from the disruptions. Though short-term market disruptions may allow investors to buy public securities at advantageous prices, the availability of such opportunities is often limited by the efficiency of the public markets and the speed at which information is disseminated.
On the other hand, in the private markets, economic disruptions create even greater long-term opportunities for investors in the private companies developing innovative solutions to the new problems created by the disruptions. Investors in private markets, particularly ultra-high-net-worth families, can also take advantage of a longer investment horizon and less-stringent regulatory requirements to generate better returns through value creation.
New Opportunities Await
Currently, short-term market disruptions are having a significant effect on the asset allocation strategies of large institutional investors like pension funds and endowments as they strive to manage risk and optimize returns. Due to strict target asset allocations, a large shift in relative asset values, like we saw last year in both stocks and bonds, will cause these investors to rebalance their portfolios to bring their targets back in line. This means that many of these institutional investors are being forced to sell their illiquid private equity investments because their portfolio allocations are now overweight.
Additionally, market disruptions and increased volatility are prompting institutional investors to reevaluate their fundamental asset allocations and risk appetites. This phenomenon creates opportunities for investors with dry powder who can now allocate capital to artificially undervalued assets or provide liquidity where traditionally none existed. Secondary private equity funds, which specialize in the purchase of shares in existing private equity funds, provide this liquidity at a price or discount to net asset value.
These funds are uniquely situated to take advantage of the phenomenon created by last year’s market disruption. Forced selling by large institutional investors have allowed these secondary funds to purchase investments at historically large discounts to NAV, delivering immediate value to their own investors. Actively selecting the top secondary fund managers is essential to maximizing long-term returns, as the difference between the top quartile and the median returns can be significant.
As we look towards the next decade, we anticipate significant changes in various industries, driven by technological advancements, demographic shifts and social disruption. The exponential growth of AI and attempts to curb climate change will also play a critical role in reshaping our economy. These factors will bring about a level of disruption that will create both winners and losers.
However, the winners are likely to emerge in the private markets, well before they go public. This makes active management in venture capital and private equity markets crucial to identifying and profiting from these opportunities. The importance of picking the right managers, who have the expertise, access and investment philosophy to spot and nurture these private companies, cannot be overstated.
The example of SpaceX, valued at $137 billion, highlights the enormous potential for private companies to create significant value before considering an IPO. Private markets provide a fertile ground for entrepreneurs to experiment and innovate without the constraints of public market scrutiny. This results in an environment that can facilitate rapid growth, transformative technologies and significant value creation.
To identify and invest in private companies that are best equipped to profit from these disruptions, it is imperative to take an active approach to private market investing and pick managers who have a deep understanding of the rapidly evolving landscape. The coming decade will bring about considerable disruptions, but those who can navigate this changing landscape and identify the winners in the private markets will be well positioned to benefit from this paradigm shift.
Though challenging, disruptions can create opportunities for those who can adapt, innovate, and take advantage of the changing landscape. You just cannot be passive about the approach.
Christian Salomone is chief investment officer of Ballast Rock Private Wealth, which specializes in private market investments.
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