How accredited investors can diversify their portfolio with private equity
For investors seeking to build resilient, high-growth portfolios, diversification is a cornerstone principle. Spreading investments across various asset classes helps mitigate risk and can potentially enhance overall returns. While traditional portfolios often rely heavily on public stocks and bonds, accredited investors have access to a broader universe of opportunities, including private equity. Incorporating private equity can offer unique diversification benefits and exposure to growth drivers often unavailable in public markets.
What exactly is private equity?
Private equity (PE) refers to capital invested in companies that are not listed on public stock exchanges. PE firms raise capital from institutional investors and high-net-worth individuals (accredited investors) to form funds. These funds then acquire stakes – often controlling interests – in private companies. The goal is typically to improve the company’s operations, strategy, and financial structure over several years before exiting the investment through a sale or initial public offering (IPO), aiming for substantial returns. This platform is a good example of a financing platform that can connect sponsors and investors for the purpose of financing private equity deals.
Common private equity strategies include:
- Leveraged buyouts (LBOs): Acquiring established, mature companies using significant debt financing, aiming to improve operations and pay down debt before selling.
- Growth equity: Investing in established but rapidly growing companies for a minority stake, providing capital for expansion, market entry, or operational improvements.
- Venture capital (VC): Funding early-stage startups and young businesses with high growth potential but often unproven business models or limited revenue.
Why diversify with private equity?
Adding private equity to an investment portfolio can offer several compelling advantages for accredited investors.
Historically, private equity has demonstrated the potential to generate higher returns than public markets over the long term. This is partly due to the “illiquidity premium” (compensation for locking up capital for extended periods) and the value created through active management by PE firms.
Private equity investments often exhibit lower correlation with traditional asset classes like stocks and bonds. Because PE assets aren’t valued daily based on market sentiment, they can be less susceptible to short-term public market volatility, potentially stabilizing a portfolio during downturns.
PE also provides exposure to a vast segment of the economy – private companies – that are inaccessible through public stock exchanges. This includes innovative startups, fast-growing mid-market companies, and specific sectors or niches not well-represented publicly.
And finally, unlike passive public market investing, PE firms actively engage with their portfolio companies. They often implement operational improvements, strategic shifts, financial restructuring, and governance changes to drive growth and enhance value before exiting.
Who qualifies as an accredited investor?
Access to private equity investments is generally restricted by securities regulations to “accredited investors.” This designation is intended to ensure that investors participating in these less-regulated, potentially riskier private offerings have the financial sophistication or capacity to bear potential losses. According to the U.S. Securities and Exchange Commission (SEC), an individual generally qualifies as an accredited investor if they meet one of the following criteria:
- Have an individual annual income over $200,000 (or $300,000 joint income with a spouse or spousal equivalent) for the past two years, with a reasonable expectation of the same for the current year.
- Have an individual or joint net worth exceeding $1 million, excluding the value of their primary residence.
- Hold certain professional certifications in good standing (e.g., Series 7, 65, or 82 licenses).
- Are directors, executive officers, or general partners of the company issuing the securities.
- Entities like banks, trusts, certain employee benefit plans, and organizations with over $5 million in assets can also qualify.
How accredited investors can access private equity
Accredited investors have several avenues to gain exposure to private equity:
- Private equity funds: This is the most common route. Investors commit capital to a limited partnership fund managed by a PE firm (the General Partner or GP). The GP calls capital as needed to make investments over several years. These funds typically have high minimum investment amounts and long lock-up periods (often 10+ years).
- Funds of funds: These vehicles invest in a portfolio of multiple underlying PE funds. This offers diversification within the private equity asset class itself but adds an extra layer of fees.
- Direct investments: Investing directly into a private company. This requires significant capital, deal-sourcing capabilities, extensive due diligence expertise, and active involvement.
- Co-investments: Investing in specific deals alongside a PE fund, often with lower fees than investing in the main fund. This requires the investor to evaluate individual deals.
- Secondary markets: Purchasing existing interests in PE funds from other investors seeking liquidity before the fund’s term ends. Valuations can vary significantly.
- Platforms and feeder funds: Newer platforms and wealth management firms sometimes offer access to PE funds or curated deals with potentially lower minimums than traditional fund commitments.
Understanding the risks and considerations
While potentially rewarding, private equity investing carries significant risks. Capital is typically locked up for 10 years or more, with limited options for early withdrawal. Investors must be comfortable committing capital for the long term.
Given the risks and complexity, thorough due diligence is crucial before committing capital. Investors should meticulously research the PE fund manager’s track record, investment strategy, team expertise, fee structure, alignment of interests (e.g., how much of their own capital is invested), and reporting transparency. Consulting with a qualified financial advisor experienced in alternative investments is highly recommended.