Strategic Secrets of Private Markets: Diversification and Risk Mitigation

When the American investor David Swensen died in May last year, the investment community around the world in general and in the US in particular grieved the loss of an innovator in the investment world. Despite the fact that Swensen never gained the fame of the likes of Warren Buffet or Benjamin Graham, he remains one of the most successful and innovative investment managers around the world in the last four decades.

During 35 years of managing Yale University's endowment fund, Swensen successfully transformed the $1.3 billion assets fund into a large investment entity which value exceeded $31.2 billion by the time of his death, making this university endowment fund the second largest in the US after Harvard and largely surpassing major university funds like Princeton and Texas.

If Swensen invested the entirety of the fund money upon handling its management for the first time in an index fund performing similarly to the reputable US index S&P 500 which witnessed two of the longest winning streaks over the last 30 years, the endowment’s wealth wouldn’t have at best case scenario exceeded the $24 billion mark. On the other hand, Swensen allowed the wealth of the fund to exceed this number by $7 billion, which clearly proves the man’s genius as an investment manager.

What differentiates Swensen from others and places him as an innovator was not the numbers he achieved. The man was not famous for the stellar returns he achieved, but rather for the unconventional approach he used to achieve these returns.

In 1985, Swensen took over the fund with a traditional portfolio comprised of 40% bonds and 60% actively managed equities. He soon began turning the portfolio upside down and the US equities percentage within the portfolio was 2.5% only upon his death, while bonds and cash did not exceed 7.5% meaning that traditional assets did not constitute one tenth of the portfolio.

The above raises a logical question: where did Swensen invest the fund’s money? In brief, the Yale fund’s strategy at Swensen’s era was mainly focused on private rather than public markets, since he believed that private markets offer promising investment opportunities that are disregarded by most public market investors.

Investment in private markets made Swensen a legend at Wall Street and made ‘Yale University’ one of the world’s richest universities. So, what are private markets, and do they differ from public markets? What advantages and investment opportunities do these markets offer? And the most important question is, how can individual investors access private market opportunities?

Private Markets … A Club Many Cannot Join

Overall, the capital market is divided into two types: public markets and private markets. Although both types are theoretically available for investment, there are big differences between them. If we begin with public markets, the clearest example or the most famous asset class is the equities listed on different exchanges and can be sold or bought by individuals. Anyone seeking investment in those firms to tap their growth potential does not need anything more than buying their outstanding shares in the market.

On the other hand, private markets represent the investment classes not available for public trading and which can only be accessed by sophisticated and high-net-worth investors. These classes include private equity, private credit, venture capital and real assets such as real estate, infrastructure projects and natural resources.

Private equity is the most famous asset class in private markets. Over the last two decades, private equity has become one of the key investment alternatives to traditional securities in developed markets and it represents one of the main components of portfolios held by many investment institutions.

The investment funds interested in this type of assets usually allocate part of their capital to buy stakes or fully acquire private firms. Targeted acquisitions are usually private firms but are sometimes partly listed on stock markets. Afterwards, the fund or investment manager works on boosting the company’s value to sell it in few years hoping to make significant profits. The ideal holding period ranges between four and seven years.

In 2006, five institutional investors led by ‘Brain Capital’ paid around $8.2 billion for an 80% stake in the Netherlands-based chipmaker ‘NXP Semiconductors’. In 2008, the five investors recovered their money with gains around four to five times their original investment in one of the most successful private equity deals in the US market. Individual investors cannot directly take part in such a big deal.

The second most famous private market class is private credit or ‘direct lending’, which is loans with certain interest negotiated between institutional investors and companies outside the public debt markets. Whereas private credit is not the most famous asset class, it achieved a big growth in the last few years driven by high demand on one hand and its attractiveness as an investment option capable of achieving great profits on the other hand.

In 2008, the American investor Warren Buffet lent ‘Goldman Sachs’ and ‘General Electric’ (GE) two loans amounting to $5 billion and $3.3 billion respectively. Two years and a half later, specifically in 2011, ‘Goldman Sachs’ and ‘GE’ fully repaid the loans to Buffet who gained $1.6 billion and $1.2 billion respectively.

Why Private Markets in Particular?

Where do companies get the funds necessary to boost their growth? Many years ago, going public was the main source of financing start-up companies. If the company was however established and mature, it would usually target the bond market. These financing options in private markets are still used and have their supporters, but private markets not public ones have become a growing source of capital to grow a large number of companies around the globe in the last few years.

In 2021, the value of financing activities in private markets increased by 20% on an annual basis and scored a record amount of $1.2 trillion. Assets under management (AUMs) in private markets increased from $7.4 trillion in 2020 to $9.8 trillion in 2021. This raises a question about this fast growth engines and the characteristics of private markets upon which institutional investors strongly bargain.

Private markets are an attractive investment option for several reasons, mainly the many untapped investment opportunities in these markets. Private markets do not have the fierce competition between investors as in public markets. In equity markets for example, the opportunities available for investors who adopt an active management approach are largely limited.

Competitors and analysts focus on this market around the clock and investment managers rarely make returns that exceed the market or the main index. In light of these conditions, mispricing rarely occurs (when the stock price is much less than its real value) to be used by active investment managers, and the strong performance in this market is mostly attributed to luck rather than skill.

In return, private markets work differently. Because these markets are far from the spotlight as they are private entities and assets, mispricing is more possible allowing experienced investment managers capable of getting outstanding and quality information about these investments to seize many opportunities and achieve huge returns for their investors.

The second notable advantage of private markets is their difficult monetization. In public markets, investors routinely pay a large premium for monetization which affects the profitability of assets of any kind. On the other hand, investors in private markets accept twice the monetization to achieve high returns on the long term.

Briefly, they avoid liquid securities in public markets for less-liquid alternatives in private markets to achieve significantly higher returns.

The Family Office: The GCC Investor Gateway to Private Market Opportunities

In the Arab market and particularly the GCC, The Family Office headquartered in Bahrain is the leading wealth management firm in the region that grants its clients access to unique and diversified global private market opportunities in different classes.

With over 18 years of experience in private investment portfolios management, the company offers its clients unconventional investment opportunities helping them build portfolios that comprise the best assets from private equity to real estate and technology to healthcare.

Thanks to a distinguished team of financial advisors and portfolio managers, The Family Office works alongside its clients to implement the investment strategy that suits their goals and the company's investment offices in Zurich, New York and Hong Kong allow investors access to unique transactions in private markets sponsored by top-tier international managers.  

In 2022, The Family Office launched the first-of-its-kind digital platform for wealth management in the GCC allowing investors to discover global investment opportunities in private markets, build a customized portfolio and simulate its performance for more than 10 years. This digital platform is characterized by its interactive tools that allow investors to build a portfolio and simulate its performance in a few minutes. Investors can also access a number of insights and investment analytics simply by creating an account on this innovative platform. They also access global opportunities that were usually limited to major investors and build a portfolio corresponding to their investment style and risk appetite.

You can sign up to the platform on the link: Join our platform.

About The Family Office:

The Family Office in Bahrain and its Riyadh-based wealth manager, The Family Office International Investment Company, are regulated by the Central Bank of Bahrain and the Capital Market Authority of Saudi Arabia, serving hundreds of family and individual investors. The firm helps clients achieve their wealth goals through custom-made investment strategies that cater to their unique needs. 

Disclaimer:

The Family Office Co. BSC (c) is a Category 1 Investment Firm regulated by the Central Bank of Bahrain, C.R. No. 53871 dated 21/6/2004. Paid Up Capital: $10,000,000. The Family Office Co. BSC (c) only offers products and services to ‘accredited investors’ as defined by the Central Bank of Bahrain.
 

The Family Office International Investment is a joint-stock closed company owned by one person. Paid-up capital: SAR 20 million. CR No. 7007701696.  It was licensed by the Capital Market Authority (No. 17-182-30) to carry out arranging, advisory and managing investments and operating funds, with respect to securities.