PE Democratization Part 1

Private equity investments have typically been only available to “sophisticated” investors. New regulations are changing that. Our first in a multi-part post where we discuss the risks inherent in adding private equity to investment portfolios.

We at Blue River enjoy writing, and that is a driving force for having a blog. Our goal is to write about topics that we find interesting and/or educational and hopefully do so in a way that isn’t guaranteed to make all but our most dedicated readers’ eyes glaze over (hi Mom and Dad).

Certainly, we have room for improvement, and we welcome feedback and questions.

In our quest to make a large topic digestible, welcome to our first multi part blog!

If you follow investment related news, you probably have heard about the push to “democratize” private investing to the retail public, both through investment advisors like us and through retirement plans and common investment products like target date funds.

Once limited to “sophisticated” big money investors like pensions, endowments, sovereign wealth funds, and very wealthy individuals, there’s some sex appeal for everyday investors to finally get invited to play in this bougee sandbox.

Much of the excitement is understandable. FS Investments reports that a private equity index has outperformed the S&P 500 over several medium- and long-term periods.[1] Of course, past performance is not indicative of future performance, but strong past results do have a knack of attracting additional investment dollars.

Given the media attention it is attracting, we want to shed some light on some risks we see, especially as these investments find their way into a brokerage account near you.

At its core, investing in private companies, either by making loans (private credit) or becoming an owner (private equity), is structurally like owning a publicly traded bond or stock. However, there are some key differences, like higher fees, a lack of transparency, and illiquidity.

Proponents of investing in private markets often point out that companies are staying private longer and there are fewer publicly traded companies. That much is true. The World Bank reports that between 1996 and 2024, the number of US publicly traded companies declined from 8000 to about 4000.[2] While that still leaves a lot of domestic companies to sift through, its dwarfed by the more than 34 million private companies counted by the Small Business Administration.[3] Most of these businesses are very small and uninvestable, but the opportunity set in private markets is immense.

Combing through this massive opportunity set is a tall task, and there are many firms doing it, including giants like Blackstone, KKR, Apollo, and Ares. These firms serve as General Partners (GPs) who raise money from Limited Partners (LPs) and pool the money to invest. Sometimes these funds are narrowly focused on an industry or only accept money for a limited time, but there are a growing number of more diverse “evergreen” funds that allow investors more chances to buy in or sell out.

As the name would suggest, private equity funds invest in the equity (stock) of private businesses and are considered owners (rather than lenders). Some PE firms will be minority shareholders in a business, and other times PE firms will purchase an entire business with the aim of increasing the value of the business so that it can be sold (maybe to another PE firm, or to a competitor) or be taken public via an initial public offering.

Private credit funds make loans to non-publicly traded companies. As with other loans, the expectation is that your initial money will be paid back by a predetermined date plus interest.

Over our next few blogs, we’ll discuss some of the features and bugs of private assets. For some investors, we think that these “alternative” investments can be an attractive addition to their portfolios.

However, just because it’s shiny and new and now available to the masses doesn’t mean that it’s right for everyone, especially if they are blind to some of the risks involved. As my college golf coach liked to say, “if you’re going to walk into a room full of snakes, turn on the lights first.”

If you have any questions about this blog, or other questions about your finances, please contact Blue River Capital Management at 503.334.0963 or at info@brcm.co.

This information is intended to be educational and is not tailored to the investment needs of any specific investor. Investing involves risk, including risk of loss. Blue River Capital Management does not offer tax or legal advice. Results are not guaranteed. Always consult with a qualified tax professional about your situation.

[1] https://fsinvestments.com/fs-insights/chart-of-the-week-2024-6-14-private-equity-outperformance/#:~:text=Small%20cap%20stocks%20confront%20growing,facing%20public%20small%20cap%20markets.

[2] https://data.worldbank.org/indicator/CM.MKT.LDOM.NO?locations=US

[3] https://advocacy.sba.gov/2024/07/23/frequently-asked-questions-about-small-business-2024/

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