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Consider private equity in your investment portfolio

Umito October 28, 2024

Inasmuch as Kiplinger Reader, it’s probably safe to say that making smart decisions with your money is important to you. So as an investor, how do you find the right balance between risk and reward? What strategy can you implement to not only help protect your wealth, but also help it grow?

The constantly evolving and changing financial landscape can be challenging. However, it makes it possible to evaluate different investments. Publicly traded investments have dominated the investment landscape for centuries. In recent years, private equity (PE) has become an attractive investment alternative to public markets. PE can offer a range of benefits that public procurement simply cannot match. This article will explore why incorporating private equity into your investment portfolio could be a strategic and smart move for create wealth.

Real diversification in a concentrated market

Diversification has always been a fundamental principle of smart strategy invest. You’ve probably heard the adage “don’t put all your eggs in one basket.” Diversification is an investment technique that aims to increase returns and reduce overall risk by spreading across different investment types and sectors.

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Over the years, public procurement has become more concentrated. In 1996, the number of U.S. companies listed on the stock exchange sharp to 8,134 before falling to less than 4,300 in 2018. The decline in the number of publicly traded companies increases the challenge of achieving true diversification through traditional stock investing. Consider this: The top 10 companies in the S&P 500 now represent about a third of the total index. Additionally, most of these companies belong to the technology sector.

Private equity, on the other hand, offers the opportunity to deepen diversification. By investing in private markets, you can gain exposure to thousands of companies across a wide range of sectors and industries. Several of these sectors are under-represented or completely absent in public markets. For example, there is nearly 200,000 mid-sized companies in the United States, the vast majority of which are private. Medium-sized companies represent a third of private sector production and are mainly private and not accessible via public markets. Investments in these companies can only be accessed through PE.

By including private equity in your portfolio, you gain access to different industries, market segments, and business models that are not as susceptible to the concentration risks seen today in public market-weighted indices, such as the S&P500. Private equity investing is a way to broaden your exposure beyond large-cap, tech-heavy giants and into the broader economic landscape.

Aligning interests for long-term success

One of the most beneficial aspects of private equity is the alignment of interests between investors and the management teams of private companies. Liquidity, an easily tradable market and accessible information are great advantages for publicly traded companies.

However, in public markets, companies are often pressured to prioritize short-term results in order to satisfy shareholders and analysts. This pressure can lead to decisions that harm long-term growth.

On the other hand, private equity is not subject to the same rigor. Often, private equity aligns management objectives with long-term performance indicators. Compensation packages in private equity-backed companies are often tied to the successful growth and operational efficiency of the company over a five- to seven-year period and are generally aligned with a successful exit.

The private equity structure encourages strategic thinking and operational stability that benefits both companies and investors. Compared to public companies, board members of private companies typically have a significant investment in the company, prioritize their prior experience and meet more frequently, and often prioritize long-term value rather than short-term accounting profits.

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Proven superior performance

How did your investment go? What was the rate of return? Did it make money? Investment performance is an investor’s scorecard. Past performance is no guarantee of future performance. However, when evaluating investment options, historical performance is an important aspect of decision making.

Ares Wealth Management Solutions, a leading global alternative investment manager, has conducted research on the performance of private equity relative to public markets over the past three decades. Overall, the research illustrates private equity’s long track record of generating superior and more sustainable returns compared to public markets.

For example, their report points out that if you had invested $100,000 in private equity (the buyout market, the largest and most mature private equity market) in 1992, today you would get an approximate value of 6 million dollars 30 years later. This is significantly higher than the approximately $1.1 million value that the same $100,000 would have generated in public markets (as represented by the MSCI World Index). This type of outperformance should not be overlooked.

In addition to superior performance, private equity has also been found to provide better downside protection, meaning less steep declines during market downturns and faster recoveries afterward, according to the Ares Wealth study Management Solutions. During the 2008 global financial crisis, for example, private equity experienced smaller declines and faster recoveries than the broader public markets. The same downside protection and faster recovery have also been evident during the COVID-19 pandemic.

Know the risks

Private equity involves risks; reduced liquidity and the need for a longer time horizon are certainly important factors in determining whether private equity is a suitable investment. Investments are not listed on any stock exchange and cannot be easily liquidated.

An additional risk that can harm the performance of private companies concerns their reporting requirements. Private companies are generally not subject to SEC reporting requirements, are not required to maintain accounting records in accordance with generally accepted accounting principles, and are not required to maintain effective internal controls over information financial. Due to the lack of reporting requirements, there is a risk that investors may invest based on incomplete or inaccurate information.

Due to an ever-changing economic landscape, the potential benefits of private equity in terms of diversificationalignment of investor interests and historically superior performance make it an investment category worth considering. Private equity can provide you with opportunities that you wouldn’t otherwise have access to in the public markets, potentially helping you find the right balance of risk and reward.

The information provided here does not constitute investment, tax or financial advice. You should consult a licensed professional for advice regarding your specific situation.

Apre-salomemanzo

Apre-salomemanzo

Consider private equity in your investment portfolio

Real diversification in a concentrated market

Umito

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Consider private equity in your investment portfolio

Real diversification in a concentrated market

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