While private markets investing has become increasingly competitive as larger funds are raised and more dry powder enters the marketplace, investors continue to be drawn to private markets investing for the high return potential. In particular, private equity as an asset class has the highest expected return potential among firms that produce capital markets expectations. Horizon Actuarial Services publishes an annual survey of capital market assumptions collected from various investment advisors. The average expected private equity return is higher than any other asset class, over both the 10-year and 20-year horizons.
In addition to higher expected returns, private markets assets have displayed lower observed volatility historically. Unlike public market securities, private market assets are not priced daily. Private markets fund managers most often value their investments quarterly, though some private market fund managers do conduct monthly portfolio valuations. As such, price changes of an asset are generally reflected on a lagged basis in reporting, and can take as long as two quarters to reflect equivalent to changes in public securities. This can result in a smoothing of returns experienced by private markets investors.
Well-crafted private markets programs have the potential to outperform their public market equivalents for a variety of reasons. As it pertains to the investments that fund managers execute, one element that can aid in generating outperformance is a manager’s ability to identify and exploit market inefficiencies. An inefficient market could be characterized as one where businesses are mispriced or misunderstood, potentially resulting in significant undervaluing. Inefficient markets may also be identified through highly fragmented industries populated with many small businesses, none of which successfully capture any meaningful market share. Private market managers, by exercising management control of business as well as having multi-year investment horizons (compared to quarter-to-quarter for public companies) can capitalize on these inefficiencies by applying long term value creation plans.
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