“How to get started in private investing?” It’s a popular search phrase in Google for good reason. More and more investors are realizing that private investments have historically provided outsized returns compared with public investments, and no surprise they want to learn more.
Consider this: Over the last 25 years, the private equity asset class has outperformed the S&P 500 by 5.7% per year on average. That difference becomes even more pronounced looking at top-tier managers. Across alternative asset strategies, the average dispersion from the median manager to the 5th percentile manager is 18%.
Large family offices and institutions are well aware of the opportunity and have long been willing to accept the illiquidity and risk of private investments in return for the prospect of higher long-term, risk-adjusted returns. In many cases, family offices and institutions allocate 40% or more of their overall portfolios to private investments in order to optimize their return.
At Cresset, we believe that the greatest opportunities to deliver consistent strong returns are found in the private markets.
But for those investors who are not part of large family offices or sophisticated institutions, what else do they need to know about private investing, and how do they begin?
Below are five things every investor needs to know before getting started in private investing:
- Know your goals, time horizon, and risk tolerance
As with any investment, being clear about the reason you are investing, and the time horizon for that investment, is critical when investing in private markets. It can be argued that is even more important than with publicly traded securities, as often private investments are “illiquid,” meaning your cash is “locked up” and inaccessible, often for several years.That reality adds an element of risk, so it is important to forecast whether you are likely to need access to the funds you plan to invest before the private investment term concludes.
- Understand the different structures of private investments
There are several different structures within private investments. Three main structures are evergreen funds, drawdown funds, and fund of funds:
+ Evergreen funds: With these funds, all capital is invested right away, such as with hedge funds, and you can add to that investment and redeem some or all of your money at specific redemption intervals (such as monthly or quarterly). It’s important to understand the redemption terms, as there can be notification requirements. Work closely with your financial advisor to ensure you understand your rights and obligations within an evergreen fund.
+ Drawdown funds: These funds include traditional private equity, private debt, and venture capital funds. Invested dollars are drawn over time as investments are made. That typically means the fund will make requests for additional money to be invested, with guidance on how to wire the funds, up to your commitment amount. In contrast to evergreen funds, there are no redemption options with drawdown funds. Essentially, you cannot access the money you’ve invested in a drawdown fund before the end of the fund term, unless the fund makes income distributions or if there is a liquidity event.
+ Fund of funds: Just as it sounds, a “fund of funds” is a fund made up of several underlying funds, which can be great for smaller investors, because a fund of funds provides diversification. However, this structure can also add an additional layer of fees.
- Be aware that alternative investments can vary widely: Choose wisely
Alternative investments are a broad asset class. Essentially, any investment that is not a traditional publicly traded stock or fixed income security can be lumped into the category of “alternatives.” There are a myriad of alternative investment options available, many with very different risk profiles and liquidity terms. That includes everything from senior secured debt (which is generally lower risk) to venture capital (which offers the potential for higher returns, but with higher risk).To help guide your decisions, determine whether you need current cash flows to fund your lifestyle today, or if your objectives are more long term. That will help considerably in narrowing down your investment options. Again, work closely with a qualified financial advisor to help ensure how you are investing fits with your overall financial plan and strategy.
- Take a close look at fees
Comparing investments net of fees is very important. Alternatives investments in general tend to have higher fees than mutual funds or ETFs, for example, but that comes with the potential for higher net-of-fees returns. There are generally two fees with a private investment, a management fee and carried interest. Carried interest is an incentive fee a fund receives if it exceeds a certain minimum return. It’s important to understand what that threshold is before making an investment decision, because fees can reduce your returns over time. For drawdown funds specifically, know whether the fee is based on the amount of dollars committed or actually invested.
- Finally, be cognizant of tax implications
With publicly traded investments (such as stocks and bonds) investors generally only have to deal with the 1099 tax form. With private investments, they generally receive a K-1 form, which is often not available until after April. That means a taxpayer with private investments will likely have to file for an extension. K-1s can also increase accounting fees and add additional complexity during tax time. On the flip side, certain private investments offer added tax benefits, such as depreciation for real estate investments, which can help reduce your tax burden. However, regardless of the tax benefit, it is important to make sure that it is a good investment that complements the rest of your portfolio.
To learn more about private investment opportunities, please contact us at
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