Private Markets Aren’t Meant to Be Fair
Ask A CIO #60
I was pretty salty after the Eagles lost in the NFC wild card playoffs. Philly fans aren’t exactly known for being reasonable or measured.
My husband, Seattle-born and raised, graciously (some might say, wisely) avoided mentioning football for a bit. And while it took me longer than it probably should have, I eventually came around in time to root for the Seahawks this past Sunday.
Huge congratulations to Seattle and Seahawks fans on a well-deserved Super Bowl win!
What happens next, though, is up in the air. The Seahawks are up for sale, and whenever the team trades hands, it’s expected to do so at a record setting price. I’ll be curious to see if the buyer that emerges includes one of the NFL approved private equity firms as a minority owner in the transaction.
Of course, above all else, here’s hoping the team stays in Seattle. I don’t think the city could stomach a repeat of the SuperSonics debacle. In our house, we still refer to OKC as the Team That Shall Not Be Named.
This week’s question is about the allure of investing in private markets through individual companies or assets, particularly if it’s an extra shiny object (like, perhaps a sports team). The question arose during a recent conversation with family office friends over dinner. The group was a mix of family offices of different sizes and investment approaches, with remarkably few investing in private markets primarily through funds.
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When does it make sense to invest in individual private market companies or assets, and when does it make sense to invest through a fund manager?
It should be a surprise to no one reading this that, when it comes to private markets, I am heavily in favor of investing through fund managers in all but the most limited of circumstances. For the purposes of this discussion, let’s set aside co-investments alongside fund managers. We’re talking here only about making one-off, individual private investments.
For the majority of individual investors, the short answer here is: never; and always.
A longer answer might be, it could make sense to invest in individual private market companies or assets if all of the below apply:
You are yourself an expert on this private market industry or investment type;
You have the network and deal flow to see most, if not all, of the investments that are related to your area of expertise; and
You understand the risks and can confidently underwrite the investment.
It makes sense to invest through a fund manager in pretty much all other scenarios.1
I’ve found over the years, and it was no different at the aforementioned dinner, that very few people want to hear this answer.
I mean, I get it. Telling folks at cocktail parties about investing into a promising private company just sounds so much cooler. It’s surely more interesting than talking about a fund manager. But at the end of the day, wouldn’t you rather just give yourself the best chance of investment success?
At one point over dinner, someone unintentionally made my point for me, saying: you’re telling me to invest alongside experts. But it feels like any time I invest alongside a buddy that is an expert in [insert industry/vertical], it underperforms!
I’m paraphrasing, and the comment was made half-jokingly, but it captured a lot of the challenging dynamics inherent to cherry picking private investments. Remember the conditions I laid out above? Including how an investor should have the network and deal flow to see most, if not all, of the private opportunities in a segment before selecting one? In this example, the investor was relying on a friend’s deal flow. It’s possible that the friend in fact has the network and deal flow. But the investor still doesn’t. And if an investor is relying on a friend, an investment club, or an online marketplace, there’s always the risk of negative selection bias.
A good heuristic, another way to frame the decision process might be asking: why are you being shown this opportunity? Are you the natural buyer of or natural investor in this company/loan/property/etc.?
Let’s assume the friend referring the investment is indeed a subject matter expert. Let’s also assume the friend is indeed a good investor in their area of expertise. But that doesn’t mean any given investment will be successful. And to go back to the central question – why are you being shown this particular investment? Why is this one getting shared?
In case it’s not obvious by now, investing in one deal shown to you by a friend, industry expert or not, is not the same as investing in a fund manager with industry expertise. Only the latter provides a thoughtfully constructed portfolio of investments where your dollars are deployed alongside that expert in every single investment that expert makes.
Here, I’ll make a concession. I fully recognize that it’s not necessarily easy to find great private markets fund managers either. And perhaps I’ve buried the lede, but investing in private markets is hard all around.
There is no presumption of fairness in private markets. There is no level playing field. Market inefficiency, information asymmetry, and the perfectly legal possession of material non-public information – these are, as the saying goes, features not bugs.
All the above said, an investor might still want to invest in individual private investments. And if the investor sizes them appropriately, recognizing the risks they’re taking, then who’s to object? Don’t we all think about buying a lottery ticket when the jackpot gets above a billion dollars?
Thanks for joining this week! As always, reach out with questions: askacio@ivyinvest.co.
See you in two weeks,
Wendy
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Let’s not even get started on the haphazard way that too many investors track individual private investments. I suspect that if these investor portfolios of individual holdings were aggregated and measured as a single fund, few would have chosen that “fund” to invest in.