Private Markets – A Growing, Alternative Asset Class
Key Takeaways
- Private markets are debt and equity investments in private companies or assets, such as private credit/debt, private equity and real assets such as infrastructure and real estate.
- Assets under management (AUM) in private markets totaled $11.7 trillion in 2022, up from $10 trillion in 2021 and $7.4 trillion in 2020.
- Over half of private market investments are made in private equity, but private credit/debt and real assets are growing rapidly.
- Private markets are projected to reach more than $15 trillion by 2025, and more than $18 trillion by 2027.
- Private markets are likely to continue growing in 2024, but more slowly.
- Alternative Investment Funds Are Likely To Expand In Number And Leverage
What are Private Markets and how do they work?
Private Capital Markets, also known as Private Markets, refer to debt and equity investments in privately owned companies, as opposed to assets traded publicly, such as stock exchanges, the bond market, and commodities markets.
Private markets work by allowing investors to put money into private companies in the form of private debt or private equity, or real assets such as infrastructure, natural resources, or real estate. In return, investors receive a share in the company or asset/s and stand to make a positive return if the company performs well or the value of the asset(s) appreciates. Conversely, they also risk losing capital if the company fails or the assets depreciate.
Private markets help companies get off the ground by giving them access to much-needed capital, while also providing investors with opportunities to achieve a potentially better return than they would through public markets.
Investors are increasingly turning to the private capital markets for better returns, as these investments have outperformed public securities in recent years.
A Short History of Private Markets
Private markets have technically been around for centuries. The first private market transaction is thought to have taken place in Amsterdam in the early 1600s when a company called the Dutch East India Company raised money from private investors to fund its voyages to the Far East.
In the 1900s, private markets began to surge in popularity as a way for companies to raise money, partly due to the development of new investment mediums such as private equity and venture capital, which allowed investors to put money into private companies.
As private markets grew in popularity, several regulatory bodies began to emerge to help protect investors and ensure that companies were being truthful about their financials. The most notable of these was the Securities and Exchange Commission (SEC), created in 1934.
By the end of the 1960s, private companies had raised over $1 billion in capital through private markets, and private markets were an increasingly important part of the economy. The 1990s saw the expansion of private markets into new geographies, with countries like China and India seeing a surge in private market activity. This was helped by the growth of the Internet, which made it easier for companies to raise money from investors around the world.
Today, private markets account for trillions of dollars in investments, and they continue to grow in importance. Private markets are an important part of the global economy and are estimated to be worth more than $11 trillion.
Types/Examples of Private Markets
There are several examples of private markets asset classes that investors can use to access private companies, including private equity, private credit/debt, and real assets.
Private Equity
Private equity is a type of private market asset class that refers to the purchase and sale of ownership stakes in private companies. Private equity investments are made by private equity firms – investment funds that pool money from investors and use it to buy stakes in private companies.
There are several different types of private equity, including:
- Fund of Funds
- Growth Equity
- Leveraged Buyouts (LBOs)
- Mezzanine Capital
- Real Estate Private Equity (REPE)
- Venture Capital (VC)
Private equity vs private markets: what’s the difference?
Private equity is simply a subset of private markets. Private markets broadly refer to investments made in assets not available on public exchanges, including private companies, debt, and real assets, while private equity specifically refers to investments made in private companies.
Private Credit/Private Debt
Private Credit, also known as Private Debt , is a type of private market asset class that refers to the purchase and sale of loans and debt securities in private companies. There are several forms of private credit, including:
- Direct lending – a form of financing provided directly by a lender to a borrower, without the involvement of a bank or other intermediary. Direct lenders typically focus on providing loans to small and medium-sized businesses (SMBs) and borrowers considered speculative/non-investment grade.
- Distressed debt – provided directly by a lender to a borrower, without the involvement of a bank or other financial intermediary. Direct lenders typically focus on providing loans to small and medium-sized businesses (SMBs) and other borrowers that are considered to be below investment grade.
- Mezzanine debt – a combination of senior debt and equity, often used to finance leveraged buyouts or other transactions where the borrower's credit rating is not strong enough to qualify for senior debt.
- Private debt fund of funds – a type of investment fund that invests in other private debt funds, and offer investors the opportunity to gain exposure to a diversified portfolio of private debt investments, without having to invest directly in individual debt
- Venture debt – provided to early-stage companies by venture capital firms, it is typically used to bridge the gap between a company's initial round of funding and its next round of financing. Venture debt lenders typically have a lower interest rate than traditional banks, but they also have a higher risk of default.
Real Assets
Real assets investing refers to the purchase of physical assets, such as real estate, infrastructure, and natural resources. Real assets can provide investors with stability and long-term returns, as they are not as volatile as traditional financial assets such as stocks and bonds.
There are several different types of real asset investments, including:
- Real Estate : a type of physical asset that refers to the purchase of property such as offices, retail space, apartments, and industrial buildings. Private Market Real Estate investments can provide investors with stability and long-term returns, as they are not as volatile as traditional financial assets such as stocks and bonds. Real estate investments can be made through private real estate funds or public real estate markets.
- Infrastructure: a type of physical asset that refers to the purchase of transportation networks (e.g. roads, bridges, airports), communication networks (e.g. telecommunications networks, data centers), or utility systems (e.g. water treatment plants, energy pipelines). Private Market Infrastructure investments can provide investors with stability and long-term returns, as they are not as volatile as traditional financial assets such as stocks and bonds. Infrastructure investments can be made through private infrastructure funds or public infrastructure markets.
- Natural Resources: a type of physical asset that refers to the purchase of commodities such as oil, gas, coal, gold, silver, and copper. Private Market Natural resources investments can be made through private natural resources funds or public natural resources markets. Each type of investment has its unique characteristics and benefits. Natural resources can provide investors with stability and long-term returns, as they are not as volatile as traditional financial assets such as stocks and bonds.
What is Private Market Investing?
Private market investing typically includes pension funds, insurance companies, private equity firms, and venture capitalists which invest in private companies through private equity funds, venture capital funds, and private debt funds.
Private market investments are typically made via a private markets fund arranged as limited partnerships, with investors referred to as Limited Partners, or LPs, and investment managers referred to as General Partners or GPs.
The Private Markets Lifecycle
The private markets lifecycle is the process by which private equity funds are created, raised, invested, and eventually liquidated. The private markets lifecycle typically takes 7-10 years to complete, although the exact timeline can vary depending on a fund's investment strategy and market conditions. It typically consists of five stages:
- Fundraising
- Capital deployment
- Portfolio monitoring
- Portfolio administration
- Value realization
Once the private fund has been raised, the GP will begin capital deployment: investing in portfolio companies. These companies can be at any stage of development, from early-stage startups to mature businesses.
In portfolio monitoring, a GP will work closely with the portfolio companies to help them grow and improve their performance. This could involve providing strategic guidance, operational support, and further capital.
Portfolio administration involves managing the day-to-day operations of a private equity fund's portfolio, including tracking investment performance, monitoring portfolio companies, managing capital calls and distributions, preparing financial reports, and complying with regulatory requirements.
Value realization , also known as an exit, happens once a GP believes that a portfolio company has reached its full potential. An exit is typically done through an IPO, sale to another company, or recapitalization.
Once a GP has exited all of the investments in a fund, the fund is liquidated and the proceeds are returned to investors.
What are some of the potential benefits of private markets investing?
For Investors:
- Higher potential returns and more stability. Private markets are typically less volatile than public markets, which is why investors might consider them a safer investment option.
- They offer investors the opportunity to get in on the ground floor of promising companies.
- Diversification. The bulk of the economy consists of private market investments. Therefore, this asset class offers access to a wide range of alternative sources of risk and return. For example, companies in the growth phase are typically not traded on a stock exchange and are therefore not part of a traditional portfolio. Private equity funds make it possible to include such investments in an allocation.
For Companies:
Private investment can help provide vital capital for companies, including start-ups looking to grow their business. As bank finance has declined along with the number of publicly-listed companies, there has been a growth in unlisted companies seeking investment capital.
For Governments:
- Helping governments to meet objectives on infrastructure and net zero initiatives.
- Allow governments to create jobs while simultaneously reducing public spending.
Private Markets Regulation
How Are Private Markets Regulated?
Private market regulation varies depending on the asset class. Both Private Debt and Equity investments in private companies are regulated by the SEC and FINRA in the United States, while private debt investments are regulated by the MPRA in the United Kingdom.
FINRA (Financial Industry Regulatory Authority) is a self-regulatory organization that regulates the securities industry in the United States. It is responsible for enforcing both Regulations D and A, as well as other regulations that apply to private markets.
The MPRA is a regulatory authority that oversees private debt investments in the United Kingdom. It is responsible for enforcing the regulations that apply to private debt markets, including rules about disclosure, minimum investment amounts, and restrictions on who can invest.
Debt investments in private companies are subject to Regulation D of the Securities and Exchange Act of 1933. This regulation prohibits general solicitation or advertising of securities and requires that all offers be made through a Private Placement Memorandum (PPM).
Equity investments in private companies are subject to Regulation A of the same act (Securities and Exchange Act of 1933). This regulation exempts private companies from registration with the SEC, as long as they meet certain requirements, such as making their financial information available to investors.
Private Markets vs Public Market Investing
What’s the difference between private vs public market investing?
Private market investing and public market investing both offer a range of benefits to market participants, but there are many differences in private markets vs public markets in terms of regulation, liquidity, information availability, and more.
Private vs public markets: a quick comparison
Private Market Size
How big are private markets in terms of assets under management (AUM)?
As of June 2022, total private market assets under management (AUM) totaled more than $11.7 trillion globally across all asset classes, up from $10.7 trillion at the end of 2021. Furthermore, there was over $3 trillion in dry powder – cash that's been committed by investors but has yet to be allocated to specific investments.
The growth in private markets is due to increasing demand from investors for high-yield and private equity investments, as well as the growth of private credit/debt markets.
Private Market AUM by Region
More than half of global private markets AUM is invested in North America, with an estimated $6 trillion, followed by Europe with $2.8 trillion, Asia-Pacific with $2.2 trillion, Latin America with $0.4 trillion, and the Middle East and Africa with $0.3 trillion.
Private Market AUM by asset class
The private market continues to be dominated by private equity, with $7.6 trillion globally in AUM as of mid-2022, followed by private debt ($2.4 trillion) and real assets ($1.3 trillion).
Private Market Trends and Outlook
Private markets are projected to reach more than $15 trillion by 2025, and more than $18 trillion by 2027. The strong growth of private credit/debt, real assets, and secondary markets is expected to continue.
Private equity outlook
Many of the private equity trends experienced in 2023 are expected to continue in 2024, including slow fundraising, elevated interest rates, a macroeconomic outlook clouded by conflict and geopolitical tension, according to S&P Global Market Intelligence’s private equity 2024 outlook.
Private equity exits fell sharply from 2021 to 2023, but there were signs of a rebound in late 2023. While this is positive news for PE markets, the difficult deal environment won’t disappear overnight and as of November 2023, the number of PE entries were tracking for their lowest annual total since at least 2019. There is, however, a record $2.59 trillion in record dry powder waiting to be committed.
Creative deal structures and a relentless focus on value creation in private equity portfolios could be critical in the coming year.
Private credit outlook
Private credit markets are projected to continue growing in 2024, albeit at a slower pace than in previous years, due to uncertain interest rates and the possibility of a US recession.
Larger issuers, middle-market, and private credit CLOs are expected to intensify activity, with alternative investment funds (AIFs) expanding in both number and leverage. Business development companies (BDCs) may encounter volatile valuations, and certain portfolio companies could struggle due to earnings pressure and higher interest costs. Meanwhile, speculative-grade issuers may have trouble servicing debt in the face of rising costs and strained earnings, which will turn challenges for borrowers into opportunities for lenders.
Both General Partner (GP)- and Limited Partner (LP)-led secondary strategies are expected to be in high demand, and valuations in private markets may become more volatile due to the macroeconomic environment.Real assets outlook.
Infrastructure and real estate fundraising fell from 2022 to 2023. Global infrastructure fundraising in particular hit its lowest level in six years, while real estate fundraising and deal flow have decreased to new post-COVID lows.
For real estate, higher interest rates, weak office demand and falling property valuations pose significant risks in 2024. There is a worry in the investment community that office and retail real estate could come under stress following the rise of home working since the pandemic, pushing workers away from urban centers. An upcoming wave of refinancing could further impact the value of investments and transaction activity.
For infrastructure, while rising interest rates and an economic slowdown have made capital more expensive and scarce (driving an overall decline in fundraising), global megatrends such as digitalization, decarbonization and deglobalization are driving new infrastructure investment opportunities.
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