For many investors, equity investing goes hand in hand with public markets and buying shares in companies listed on indexes like the FTSE 100 or S&P 500. These investments are typically highly liquid, and prices are updated in real-time. But beyond the ticker tape lies a deeper pool of potential opportunity – private equity.
As market volatility and uncertainty persist, more investors are seeking diversified sources of return. Private equity is increasingly gaining attention for its potential to deliver.
This article isn’t personal advice. If you’re not sure whether an investment is right for you, ask for advice. Private markets are considered high-risk investments for experienced investors and should only form a small part of a diversified portfolio. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.
What is private equity?
Private equity is the counterpart to public equities. Rather than purchasing small, tradable stakes in listed companies, private equity involves taking larger ownership positions – either minority or controlling stakes – in unlisted businesses, outside the markets.
Private equity funds go beyond simply “buying and holding”, instead actively managing businesses and driving decisions over governance, operations and strategic direction – all with the aim of increasing their value, and hopefully increasing their returns. The targeted outcome is a profitable exit, typically through a sale or public market listing.
Why consider investing in private equity?
There’s several reasons why private equity can enhance an investment portfolio:
Access to a broader universe: Private markets are far larger than public equivalents, including start-ups or established businesses seeking growth capital.
Diversification: Private equity returns tend to differ from public markets, making it a useful diversifier.
Return potential: Historically, private equity has generally delivered higher long-term returns than public markets, although it’s important to remember that past performance is not a guide to the future.
Active ownership: Private equity investors often help shape the future of their investments, driving value through operational improvements.
Insulation from market noise: Private businesses aren’t priced daily, they’re shielded from the short-term volatility of public markets.
What are the types of private equity?
Private equity isn’t one-size-fits-all. It spans a range of strategies based on the stage of business maturity and type of ownership.
Venture capital
This is the earliest stage of private equity. Venture capital involves backing pre-profit businesses with innovative ideas and strong growth potential. This could be tech start-ups or biotech firms yet to commercialise their breakthrough ideas.
Returns potential is high, but success is driven by a few standout performers so the type of outcome is wide and varied.
Venture capital carries a high level of risk due to the uncertainty around early-stage business models. Although risks can be managed through due diligence and replicable processes, they won’t be fully reduced.
Growth capital and buyouts
Growth capital typically involves taking minority stakes in more mature companies that need funding to scale. Buyouts go a step further, involving the full or majority acquisition of a business.
With growth capital, it’s all about backing companies with proven models looking to expand into new markets or products.
While buyouts can target firms of any size, but small/mid-cap buyouts are especially attractive for their transformational growth potential. Again, in smaller segments return potential is greater but so is dispersion, making selection key.
Secondaries and co-investments
These provide alternative and flexible access points into private equity.
Secondaries are when private equity buys into businesses that are already under private equity ownership. This is through either acquiring an interest in a whole fund from another investor, or investing alongside a private equity fund manager. The latter extends their ownership of select portfolio companies through continuation funds, with the aim of realising a new phase of growth. Characterised by shorter holds and greater visibility on performance.
Co-investments is joining alongside a lead manager investing into a single company, often at reduced fees. These investments add direct exposure to high-conviction companies in a fund portfolio.
What about fees, liquidity and returns?
Private equity is a long-term, illiquid asset class. Traditional funds often have life spans more than 10 years, during which investor capital is generally locked up.
Returns can vary depending on the strategy, stage and manager skill. As a benchmark, buyout funds typically target a return more than two times the invested capital. Venture and small-cap strategies might offer even greater upside, but as above also come with higher variability.
But fees are more than in public markets. The traditional structure is 2 and 20 – a 2% annual management fee and a 20% performance fee on gains beyond a set threshold, although competition has driven fees lower in recent years.
The rise of secondaries, co-investments and so-called ‘semi-liquid’ vehicles, such as long-term asset funds (LTAFs), is also making private equity more accessible, with evolving fee models and liquidity terms.
Who is private equity for?
Private equity has traditionally been the domain of institutional investors, but that is changing. Individual investors – especially those with longer time horizons – are increasingly seeking exposure to this asset class, attracted by its diversification benefits and long-term return potential.
Listed private equity investment trusts and newer options such as LTAFs remove barriers to entry, allowing a wider range of investors to participate while offering some liquidity flexibility.
Find out more about private equity, private markets and opportunities to invest in them by visiting our Advanced Investing pages.