In the ever-evolving landscape of investment opportunities, private equity stands out as a dynamic and strategic avenue for investors seeking higher returns and actively participating in business growth. Private equity involves investing in privately held companies, providing capital in exchange for ownership stakes. This alternative investment class offers a distinct set of advantages that savvy investors should carefully consider.
Understanding Private Equity
Private equity is a form of investment that focuses on companies not traded on public stock exchanges. Instead, investors typically pool their funds into private equity funds managed by professional fund managers. These funds, in turn, invest in various private companies, ranging from startups to established enterprises.
Growth of Private Equity
In 1996, there were roughly 8,000 firms listed in the U.S. Stock Market. Since then, the national economy has grown by nearly $20 trillion, and the population has increased by 70 million people. Interestingly enough, there are now less than 4,000 publicly traded companies in the US. The chart below displays this trend from 2000 to 2019.
While our economy has grown and the best businesses in the U.S. are publicly traded, many smaller companies have remained private for longer due to costs and regulations associated with going public. This trend has given rise to more private equity funds to try to take advantage of investing in these companies that forgo an IPO.
Key Characteristics
- Long-Term Horizon: Unlike publicly traded stocks, private equity investments are characterized by a longer investment horizon, often spanning five to ten years. This extended timeframe allows companies to implement strategic initiatives and realize their full growth potential.
- Active Participation: Private equity investors often play an active role in the companies they invest in. This hands-on approach provides an opportunity to influence strategic decisions, operational improvements, and overall performance, fostering a more direct and impactful relationship with the invested businesses.
- Potential for Higher Returns: Private equity investments have the potential for significant returns, outperforming traditional asset classes like stocks and bonds over the long term. This is attributed to the active involvement in portfolio companies and the ability to capitalize on their growth.
Considerations for Investors
- Risk and Reward: While the potential for higher returns is enticing, private equity investments come with higher risk due to the illiquid nature of the assets. Investors should carefully evaluate their risk tolerance and investment goals before diving into this asset class.
- Diversification: Private equity can be an excellent diversification tool for a well-rounded investment portfolio. Balancing traditional assets with alternative investments like private equity can help mitigate risk and enhance overall portfolio performance.
- Due Diligence: Thorough due diligence is crucial when selecting a private equity fund. Investors should scrutinize the fund manager’s investment strategy, and the industries in which they specialize. Understanding the fund’s investment thesis and alignment with personal investment goals is paramount.
In an era of financial complexity, private equity offers a strategic and rewarding investment option for those willing to embrace a longer investment horizon and actively participate in the growth of promising companies. As with any investment, thorough research, risk assessment, and a clear understanding of personal financial objectives are essential before venturing into the realm of private equity. By carefully considering these factors, investors can unlock the potential for enhanced returns and actively contribute to the success stories of the businesses they support.
Presented by the Financial Planning Committee of Lake Street, an SEC Registered Investment Adviser
The information contained herein constitutes general information and is not directed to, designed for, or individually tailored to, any particular investor or potential investor. This report is not intended to be a client-specific suitability analysis or recommendation, an offer to participate in any investment, or a recommendation to buy, hold or sell securities. Do not use this report as the sole basis for investment decisions. Do not select an asset class or investment product based on performance alone. Consider all relevant information, including your existing portfolio, investment objectives, risk tolerance, liquidity needs and investment time horizon. Diversification does not ensure a profit or guarantee against a loss. There is no assurance that any investment strategy will be successful. Investing involves risk and you may incur a profit or a loss.
