Once considered speculative, private markets continue to evolve, especially as the structural hurdles for ultra-high-net-worth (UHNW) investors have come down. Still, no matter the level of expertise or market environment, investors and advisors who understand this segment of the market will be in a much better position to make informed and comprehensive decisions about their portfolios.
This Truth Revealed series explores private market investing with three objectives in mind:
- To dispel some of the incorrect notions about private markets
- To help investors and advisors better understand private markets’ potential to outperform public markets
- To assist investors and advisors as they consider how private markets investing may align with their investment objectives
The private markets universe is less concentrated and larger today than any other time in history.
What you should know
- Private equity has experienced exponential growth over the last several decades.
- The universe of private equity investors has increased, particularly among the UHNW segment.
- The number of privately held companies in the U.S. dwarfs that of public companies, which translates to considerably more opportunities for private market investors.
Global participation in private markets has swelled from $600 billion in AUM in 2000 to $9.7 trillion in AUM in 2022.
Over the last several decades, there’s been an explosion in private market investments opportunities. At the same time, there’s been a deluge of incorrect information circulating in investor circles. This may stem from the fact that, for many decades, only Institutional investors and very UHNW investors had access to private markets. Furthermore, this asset class had complex regulatory and structural hurdles. This left a large swath of investors and advisors on the sidelines, many of whom grew skeptical about the potential residing in private markets.
Further, there’s often confusion about what “private markets” actually means. The largest segment of private markets is private equity, which includes buyout, venture capital and growth equity strategies. Because private equity represents such a significant portion of private market activity, they are sometimes used interchangeably – which has unwittingly muddied the waters.
Still, there is much more to private markets than private equity. For instance, the next-largest slice of the private markets pie is private credit, followed by real estate and infrastructure.
Private Markets NAV
By Geography and Strategy
As an asset class, an important turning point for private equity was the Global Financial Crisis, which caused investors considerable pain even though private equity experienced unprecedented growth. This sounds counterintuitive, we know. But remember that between October 2007 and March 2009 the stock market dropped by more than 50%, and investors were losing faith in public markets, real estate and hedge funds. During the same period, private equity-backed firms were continuing to attract investors and performed remarkably well, especially in comparison to their public market counterparts.
Private market AUM grew to $9.7 trillion in 2022 thanks to an increasing number of private equity funds and assets, not to mention a larger universe of investors keen on testing the waters. Today, there are also fewer concerns over investing in private markets, such as asymmetric information and manager risk. This, in turn, has increased investor appetite for private equity – especially among those investors who are looking to outperform the public markets but previously thought private equity was out of reach.
As we look more closely, it’s easy to see why private equity investing is on an upward trajectory. With more than 95,000 private companies in existence globally with annual revenues over $100 million, private equity investment opportunities abound. What many people may not realize is how this compares to the universe of public companies: As of February 2022, there were 95,000 private companies with $100 million+ revenues versus 10,000 public companies with the same annual revenues.
The number of private companies dwarfs the number of public companies.
Public and Private Companies LTM revenue > $100M
We believe that private market growth – both in size and revenue – will continue. We also believe that HNW investors would be wise to continue educating themselves about private equity and how it may align with their investment objectives.
All Private Markets – Hamilton Lane’s definition of “All Private Markets” includes all private commingled funds excluding fund-of-funds, and secondary fund-of-funds.
Co/Direct Investment Funds – Any PM fund that primarily invests in deals alongside another financial sponsor that is leading the deal.
Continuation Vehicles – A vehicle in which secondary buyers acquire one or more assets from an existing fund.
Corporate Finance/Buyout – Any PM fund that generally takes control position by buying a company.
Credit – This strategy focuses on providing debt capital.
Distressed Debt – Includes any PM fund that primarily invests in the debt of distressed companies.
EU Buyout – Any buyout fund primarily investing in the European Union.
Fund-of-Funds (FoF) – A fund that manages a portfolio of investments in other private equity funds.
Growth Equity – Any PM fund that focuses on providing growth capital through an equity investment.
Infrastructure – An investment strategy that invests in physical systems involved in the distribution of people, goods, and resources.
Late Stage VC – A venture capital strategy that provides funding to developed startups.
Mega/Large Buyout – Any buyout fund larger than a certain fund size that depends on the vintage year.
Mezzanine – Includes any PM fund that primarily invests in the mezzanine debt of private companies.
Multi-Stage VC – A venture capital strategy that provides funding to startups across many investment stages.
Natural Resources – An investment strategy that invests in companies involved in the extraction, refinement, or distribution of natural resources.
Origination – Includes any PM fund that focuses primarily on providing debt capital directly to private companies, often using the company’s assets as collateral.
Private Equity – A broad term used to describe any fund that offers equity capital to private companies.
Real Assets – Real Assets includes any PM fund with a strategy of Infrastructure, Natural Resources, or Real Estate.
Real Estate – Any closed-end fund that primarily invests in non-core real estate, excluding separate accounts and joint ventures.
ROW – Any fund with a geographic focus outside of North America and Western Europe.
ROW Equity – Includes all buyout, growth, and venture capital-focused funds, with a geographic focus outside of North America and Western Europe.
Secondary FoF – A fund that purchases existing stakes in private equity funds on the secondary market.
Seed/Early VC – A venture capital strategy that provides funding to early-stage startups.
SMID Buyout – Any buyout fund smaller than a certain fund size, dependent on vintage year.
U.S. Mega/Large – Any buyout fund larger than a certain fund size that depends on the vintage year and is primarily investing in the United States.
U.S. SMID – Any buyout fund smaller than a certain fund size that depends on the vintage year and is primarily investing in the United States.
U.S. & EU Growth – Includes all growth equity funds investing in North America and Western Europe.
U.S. & EU VC – Includes all venture capital funds investing in North America and Western Europe.
VC/Growth – Includes all funds with a strategy of venture capital or growth equity.
Venture Capital – Venture Capital incudes any PM fund focused on financing startups, early-stage, late stage, and emerging companies or a combination of multiple investment stages of startups.
Barclays U.S. Corporate Aggregate Index – Tracks the performance of U.S. fixed rate corporate debt rated as investment grade.
BofAML High Yield Index – The BofAML High Yield index tracks the performance of below investment grade U.S. dollar-denominated corporate bonds publicly issued in the U.S. domestic market.
Credit Suisse High Yield Index – The Credit Suisse High Yield index tracks the performance of U.S. sub-investment grade bonds.
Credit Suisse Leveraged Loan Index – The CS Leveraged Loan Index represents tradable, senior-secured, U.S. dollar-denominated non-investment grade loans.
DJ Brookfield Global Infrastructure Index – The DJ Brookfield Global Infrastructure Index is designed to measure the performance of companies globally that are operators of pure-play infrastructure assets.
FTSE/NAREIR All Equity REIT Index – The FTSE/NAREIT All Equity REIT Index tracks the performance of U.S. equity REITs.
HFRI Composite Index – The HFRI Composite Index reflects hedge fund industry performance.
MSCI USA Small Cap Value Index – The MSCI USA Small Cap Index is designed to measure the performance of the small cap segment of the U.S. equity market.
MSCI World Energy Sector Index – The MSCI World Energy Sector Index measures the performance of securities classified in the GICS Energy sector.
MSCI World Index – The MSCI World Index tracks large and mid-cap equity performance in developed market countries.
Russell 3000 Index – The Russell 3000 Index is composed of 3000 large U.S. companies, as determined by market capitalization.
S&P 500 Index – The S&P 500 Index tracks 500 largest companies based on market capitalization of companies listed on NYSE or NASDAQ.
Desmoothing – A mathematical process to remove serial autocorrelation in the return stream of assets that experience infrequent appraisal pricing, such as private equity. Desmoothed returns may more accurately capture volatility than reported returns. The formula used here for desmoothing is:
Where rD(t) = the desmoothed return for period t, r(t) = the return for period t, ρ = the autocorrelation
rD(t) = (r(t) – r(t-1) * ρ) / (1 – ρ)
PME (Public Market Equivalent) – Calculated by taking the fund cash flows and investing them in a relevant index. The fund cash flows are pooled such that capital calls are simulated as index share purchases and distributions as index share sales. Contributions are scaled by a factor such that the ending portfolio balance is equal to the private equity net asset value (equal ending exposures for both portfolios). This seeks to prevent shorting of the public market equivalent portfolio. Distributions are not scaled by this factor. The IRR is calculated based off of these adjusted cash flows.
Sharpe Ratio – The Sharpe Ratio is the average return earned in excess of the risk-free rate per unity of volatility or total risk.
Time-weighted Return – Time-weighted return is a measure of compound rate of growth in a portfolio.
Volatility – Volatility is a statistical measure of dispersion of return, specifically standard deviation.
15-Year Asset Class Performance Chart: 15-Year Asset Class Performance: Indices used: Hamilton Lane All Private Markets with volatility desmoothed; Hamilton Lane All Private Equity ex. Credit and Real Assets with volatility desmoothed; S&P 500 Index; Russell 3000 Index; MSCI World Index; HFRI Composite Index; Hamilton Lane Private Credit with volatility desmoothed; Credit Suisse High Yield Index; Barclays Aggregate Bond Index; Hamilton Lane Private Real Estate with volatility desmoothed; Hamilton Lane Private Infrastructure with volatility desmoothed; Hamilton Lane Private Natural Resources with volatility desmoothed; FTSE/NAREIT Equity REIT Index; DJ Brookfield Global Infrastructure Index; MSCI World Energy Sector Index. Geometric mean returns in USD. Assumes risk free rate of 2.4%, representing the average yield of the ten-year treasury over the last fifteen years.
Spread of Returns by Down and Up Markets Chart: Spread of Returns by Down and Up Markets: Up markets are defined for equity strategies if the vintage year was above 11% IRR and down otherwise. Real Estate and credit strategies had a threshold of 9% for up markets.
Real and Nominal Return of Select Asset Classes Chart: Real and Nominal Return of Select Asset Classes: All inflationary periods since 1928 are defined as years where inflation was above the median level of 2.7% and increased over the respective year by more than 1%. Nominal returns taken as the median within the respective high and low inflationary periods. Real returns for both U.S. Bonds and Private Credit calculated as [(1+median nominal return)/ (1+Inflation in the median nominal return period)]-1.U.S. Bond returns calculated using a mix of 50% US T.Bond and 50% Baa Corp Bond annual returns.
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The following hypothetical example illustrates the effect of fees on earned returns for both separate accounts and fund-of-funds investment vehicles. The example is solely for illustration purposes and is not intended as a guarantee or prediction of the actual returns that would be earned by similar investment vehicles having comparable features. The example is as follows: The hypothetical separate account or fund-of-funds consisted of $100 million in commitments with a fee structure of 1.0% on committed capital during the first four years of the term of the investment and then declining by 10% per year thereafter for the 12-year life of the account. The commitments were made during the first three years in relatively equal increments and the assumption of returns was based on cash flow assumptions derived from a historical database of actual private equity cash flows. Hamilton Lane modeled the impact of fees on four different return streams over a 12-year time period. In these examples, the effect of the fees reduced returns by approximately 2%. This does not include performance fees, since the performance of the account would determine the effect such fees would have on returns. Expenses also vary based on the particular investment vehicle and, therefore, were not included in this hypothetical example. Both performance fees and expenses would further decrease the return.
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As of May 31, 2023