By Daniel Archibald | CFA
It seems that one of the big attractions of investing in property is the notion of tangibility. The fact that you can see, touch and smell the bricks and mortar of an investment property gives an added comfort to owners; as opposed to the feeling of separation felt be owning less direct investments such as shares in a business or units in a managed fund. Private property investment might also offer owners enticing additional returns based on the uniqueness of any particular property and reduced liquidity.
When it comes to the other traditional asset classes, equities and bonds, there are also similar opportunities for investors to gain access to unique and non-market assets: Private equity (PE) and private debt. Similar to a private stake in a property, private equity and private debt offer investors holdings in companies that are not publicly traded and that are often in smaller and more obscure businesses.
Private equity
Whilst many of the world's largest companies have their shares widely distributed through public stock markets, there is a growing number of smaller companies that seek capital via PE investors. This can be through 'Shark Tank'-like negotiations and can involve one or a syndicate of investors.
A common structure for such deals is through a specialist PE manager. This primary investor, also known as the 'general partner' (GP), acts on behalf of end investors, also known as limited partners (LP). GPs go well beyond the scope of a normal equity fund manager, and offers LPs a diverse range of return avenues (as opposed to listed shares that are primarily driven by overall market sentiment, monetary settings and business conditions). Functions of a GP include:
- Negotiating share price/equity ownership
- Coordinating capital contributions - which is often staged over a number of years
- Monitoring company performance and capital call milestones
- Often serve on the company board to help with management and strategic growth
Private debt
Whilst the primary avenue used by large companies in borrowing funds is by issuing bonds that can be traded on the bond market, and the primary avenue for smaller companies is to seek loans from a bank (or bank syndicate), a growing venue for corporate debt is through private deals. Like PE, private debt (or private credit) is usually organised through a GP acting on behalf of a pool of end investors (LPs). The GP is likely to have specialist knowledge of the loan market and usually focusses on the higher yield end of the corporate debt market.
Distressed securities
PE and private debt managers are more likely to finance smaller companies, that might have more risk, thus offering higher returns. Specialist managers in this space, especially those with an expert knowledge of bankruptcy processes, might also look to invest in the debt or equity classes of companies in distress. This may simply be to snap up shares and bonds that are trading at overly-depressed levels, but often it is to help manage restructuring and rejuvenation in order to bring the company back into the black.
Private assets like property, PE and private debt are likely to face different return patterns to more traditional and liquid asset classes. Most of these investments are only meant to be long-term in nature, with short-term withdrawals being restricted or coming with penalties. Also, these type of investments often require additional capital to be provided along the way. Additional risks such as illiquidity, capital calls and smaller company idiosyncrasies are likely to add to the uncertainty of outcomes, but might also be expected to reward investors accordingly.