Firstly, let’s take a look at the concept of private markets themselves. Private markets financing provides capital in exchange for equity or debt stake in a non-listed company or assets. It encompasses a broad spectrum of investment strategies that cover every stage of a company’s life cycle. For example, private equity is used for financing start-ups (venture capital), as well as for providing capital to a profitable, growing company, e.g. to support an acquisition (growth cap­ital). It is also used to take over a mature company for expansion or a refocusing (a leveraged buyout) or for purchasing a distressed company to restruc­ture it (turnaround capital). Private equity is part of private markets along with private debt and private real assets financing.

How can investors gain access to private markets?

In theory, anyone can invest directly in private com­panies or assets. However, this requires significant expertise, resources, and time in order to do it pro­fessionally across all industries, at each development stage of a company or asset, and on a global scale.

Therefore, investors can pool their capital in private markets funds and delegate the task of investing at a company’s specific development stage to local experts (fund managers), thereby making use of industry expertise.

What are the stages of private market financing?

Private markets fund managers raise capital from sources such as pension funds, endowments, sov­ereign wealth funds, insurance companies, family offices, and, increasingly, high-net-worth individu­als. The private markets funds are set up through a contractual agreement (i.e. fund regulations, such as a limited partnership agreement) between a fund manager (often referred to as the general partner or ‘GP’) and investors (often referred to as the limited partners or ‘LP’) for a preset period of usually ten years.

Then, the fund managers progressively deploy the capi­tal by investing in or purchasing businesses or assets during the investment period of the fund (usually during the first five years of a fund’s lifespan). They then transform these companies and assets before listing them on a stock exchange (through an initial public offering) or selling them to other companies (through a trade sale) or sometimes to other pri­vate markets funds (via a secondary buyout).

This divestment process can start during the investment period, but investment exits usually happen during the divestment (or ‘harvesting’) period (usually the last five years of the fund’s lifespan). Investors own most of the fund and have limited liability, whilst the manager owns a small portion of the fund but has full liability and the responsibility for executing and operating the investments.

As a result, private markets fund managers are longer-term investors but temporary owners of assets. In private equity, they typically invest in com­panies for around three-to-five years in an effort to build lasting and sustainable value through their transformation and, in some cases, provide these businesses or assets with the time needed to be profitable. To return capital to investors and secure a performance fee for themselves (known as the ‘carried interest’), managers must sell companies or assets for a higher price than they had initially paid, which is why the business or asset must be in a bet­ter or more desirable condition than when it was acquired.

What does a private markets fund manager do?

The aim of private markets fund managers is to cre­ate value in the underlying investments and then monetise that value, thereby increasing the wealth of investors. They look for companies or assets with high-quality management teams, strong potential, and a credible plan to grow the value of their busi­nesses. Of course, fund managers can strengthen or replace management teams if needed. Fund man­agers and management teams work closely together to implement new strategies.

As part of this process, they seek to align incentives, improve business plans, make operational improvements, strengthen corpo­rate governance, and invest fresh capital, if required. Fund managers support businesses thanks to a highly disciplined approach and careful planning, while remaining lean and flexible to adapt to shifting conditions.

Since private markets are characterised by a recur­ring lack of information, fund managers must perform a thorough due diligence on the companies or assets they would like to invest in as a means of shedding light on their strengths and weaknesses. In doing so, they also must develop sound initial investment rationales. By targeting growth sectors and new markets, fund managers can emphasise revenue generation and implement plans that lead to operational improve­ments and acquisitions, where appropriate.

The strength of the private markets investing model lies in the alignment of interests between fund managers and management teams: both share a common vision and are financially motivated to maximise value. Private markets investing fosters a hands-on governance model by combining active ownership and constant and effective oversight with clearly defined goals and timing, disciplined decision-making, and deep resources to match.

What about private markets in a portfolio context?

Consideration about whether to make investments in private markets funds should be made within the context of an already diversified investment port­folio. Higher return potential comes at the price of longer holding periods and, in some cases, a higher risk, depending on the choices made in terms of portfolio construction, instruments, and strategies, as well as industry exposure. The precise private markets asset allocation will depend on a investor’s specific risk tolerance, financial circumstances, and particular investment objectives.

The bottom line? To gain a comprehensive exposure to various com­panies, innovations, and economies, investors should consider both public and private investments within a diversified financial portfolio.