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What is Private Equity? Why Invest in It?

29 Nov 2022

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Contents: 

Key takeaways:

  • Private equity refers to taking stakes in a privately owned company NOT publicly traded
  • Over the past 20 years, private equity has outperformed the major public markets
  • Private equity has an attractive risk-return profile and is known for being resilient

What is private equity?

To understand what private equity is, let us first understand what equity is. Equity simply means having a piece of ownership in a company when you provide capital to that said company.

Public equity refers to owning shares in a company that is publicly traded on a stock exchange, whereas private equity refers to owning shares in a privately owned company NOT publicly traded.

Examples for the former include owning shares of Apple and/ or Microsoft, while for the latter includes owning shares of say company AB and/ or CD.

So, why would you want to own shares in unknown, private companies?

Well, as a start, private equity has outperformed the major public markets over the last 5-, 10-, 15- and 20-year periods*.

In addition, over the last 25 years, the addition of an allocation to private equity has provided an improved risk/return profile for diversified portfolios.

See the graph below sourced from Cambridge Associates.

Represents pooled horizon IRR and first-quartile return for the Global All Private Equity Index from Cambridge Associates as of December 31, 2021, which is the latest data available. Index is unmanaged and not available for direct investment. 

But that is not all, private equity also offers benefits to investors in the following ways:

Higher returns

Compared with all other asset classes, private equity historically has the highest annualised return coupled with a volatility that is far lower than any asset class. In other words, it has an attractive risk-return profile.

See the graph below sourced from Bloomberg, MSCI, Cambridge Associates, KKR Global Macro & Asset Allocation analysis.

From 1Q86 to 4Q20 where data is available, deemphasizing 2008 and 2009 returns at one-third the weight due to the extreme volatility and wide range of performance, which skewed results. Using MSCI AC World Gross USD for Listed Equities; Barclays Global Agg Total Return Index Unhedged USD for Fixed Income; Cambridge Associates Global Private Equity for Private Equity; HFRI Fund Weighted Composite Index for Hedge Funds; and Barclays US T-Bills 3-6 Months Unhedged USD for Cash. 

Resilient

Despite volatility over the last few decades, the private equities market has been enormously resilient. This is primarily due to private equity managers having a hands-on approach to managing companies with a deep bench of talent at their disposal. As such, they are therefore well-equipped to identify difficulties early on as well as pivot their approach during downturns to help their companies successfully weather the storm.

Key considerations and risks for private equity investors

Low liquidity

Private equity managers invest in or acquire companies with the goal of creating value over the long term and not rapidly entering or exiting investments based on market sentiment. As such, it has long lock-up periods, typically ranging from 8 to 14 years. The tradeoff is that investors should be compensated for this low liquidity.

Less transparent

There is currently a lack of transparency with private assets as by its nature are “private” and lack visibility to financial performance compared to public markets.

High minimums

Traditionally, investment minimums for private equity are in the hundreds of thousands if not millions of dollars. Moreover, you must be a sophisticated investor which includes a high net-worth individual or entity or sophisticated investor to gain access to it.

KLDX changes all this. By leveraging blockchain and smart contract technology, we make private equity investing accessible to all types of investors, for a low investment amount.

In addition, there are no lock-up periods when you invest in private equity on KLDX, thanks to our secondary trading platform that is soon to launch. Moreover, expect greater transparency as financial statements, progress reports and material developments in companies are all easily accessible.

Learn how here

To start investing in private equity with KLDX, start here

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