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Investing
21 Sep 2021 6 min read

Investing in private assets – Risks vs Returns

Investing

Investing in private assets – Risks vs Returns

Tue Sep 2021 6 min read
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Private assets have been attracting the interest of not only institutional investors and the ultra-wealthy, but all types of investors. In fact, private assets under management (AUM) globally stood at US$ 10.7 trillion at the end of 2020 and it’s predicted they are likely to close 2025 at US$ 17.2 trillion, for a CAGR of 9.8%1. Similarly, private-equity AUM ended 2020 at USD 4.4 trillion, and is expected to close at USD 9.1 trillion by 20252. Similarly, private debt hit a total AUM of US$887 billion as at June 20203, with 11.4% annual growth expected through to 20254.

What are private assets?
Private assets are investments that are not listed on any exchange, but are monies channelled to funds and instruments such as private equity, venture capital and private debt. They also encompass personal assets like art or rare wines.

Why is private equity growing?

The interest in private assets actually started right after the 2008 Global Financial Crisis which forced commercial banks to cut their lending. The result was a shift away from a reliance on traditional banking to private-debt markets.

However, as the overhang of the COVID-19 pandemic continues to bring uncertainties to both public and private markets, governments and central banks have been trying to support their markets by pumping liquidity into their financial systems. These stimulus measures have put considerable pressure on central banks and economies and added another layer of uncertainty in the form of inflationary pressure.

At the same time, uneven rates of vaccination and recovery, as well as subsequent waves of infections, lend volatility and risk to global investments. Bain & Company, in a 2021 Private Equity Market Report, suggests that the challenges will remain through 20225.

Public versus private investment: The risks

Despite the impressive growth, there are of course risks associated with investing in private assets. This includes: investment minimums, liquidity risks, and market risk.

Typically, when investing in private assets there is a higher barrier to entry than investing in the public market due to large capital requirements – even the lower end of the threshold can be a minimum of US$ 250,000. With such large quantums to commit there’s a lot to gain, but equally a lot that can be lost.

Then there’s liquidity risk. The nature of private investing usually requires investors to leave their funds for a longer investment period (usually four years or more) than public market investing which can be traded daily. However, private market investors don’t necessarily have to wait for a small company to make large profits. When the valuations rise – which can happen independently of profit, they can make a gain. Furthermore, if investors want to sell their public investments, there is no exchange for them to offload, they need to find buyers themselves.

Looking at market risk, private equity investors incur greater risk as there is no guarantee that the companies they are investing in will grow. While other asset classes also carry market risk, the reality for small businesses is that they carry more operational risk compared to established publicly listed companies.

That being said, a balanced approach is always recommended. With private equity funds in your portfolio, you only need to hit a couple of “home-runs” to generate favorable returns. It’s also important to remember that risks are present in every investment decision, but when private equity investment goes right, the returns have the potential to be significantly higher. As such, private market investments should not be overlooked as they offer specific advantages which are hard to ignore.

The rise of private asset investing

Diversification options and higher returns are well-known advantages of investing in private assets. This is supported by research that shows that the long-term returns of private assets exceed those of public assets.

For example, the U.S. Private Equity Index by Cambridge Associates returned an average of 10.48% annually between 2000 and 2020, compared to 5.91% for the S&P 500.

A similar picture emerges for private debt.

In a 2019 Financial Journal, it was estimated that returns on private debt averaged 1.53% per month between 2001 and 2015, substantially higher than J.P. Morgan Asia Credit Index’s 0.58%.

Other pockets of outsized growth in alternative assets also exist, particularly in China.

China is at the stronger end of the global K-shaped recovery from the pandemic, with a GDP growth forecast of 8.4% for 2021 by the International Monetary Fund.

The size of China’s domestic market makes it a compelling investment destination for investors who seek diversification from global markets, as well as returns from onshore business growth.

China is also the third largest private equity market in the world, with US$ 60 billion in additional capital invested through 20196.

In Q1 2020, Preqin also ran a study of institutional investors’ attitudes towards the key components of private assets. It found the following:

  • 65% of the investors said they invested in private equity in search of diversification
  • 55% cited higher absolute returns as a reason for considering private-equity investments
  • Private debt attracted an even higher proportion of investors: 70% sought private debt for diversification and 40%, for reliable income streams7.

Private assets with flexible terms at LU Global

Adding private assets to your portfolio of public securities can bring strategic diversification. While private investments were once restricted to institutional and ultra-wealthy investors LU Global offers accredited investors in Singapore, and registered users throughout Southeast Asia access private equity and private-debt funds with small minimum sums and lower investment tenors, as short as three months. We offer convenient access to a cross-section of underlying securities across private equity, private debt, collateralized loan obligations, commercial mortgage-backed securities, among others.

Our mutual funds also allow investors to pursue thematic diversification into technology, climate change, and environmental, social and governance investing. These unique bite-size fund opportunities have helped ease entry to these highly sought after investment opportunities while committing to lower minimum investment amounts.

Final thoughts

Private assets can play an important role in asset allocation strategies and help balance factors such as liquidity, risk, income, and returns. In this climate of uncertainty, it’s recommended to acquire a broad stable of investments to hedge against volatility. According to a survey by Preqin in November 2021, a predominant 93% of the investors surveyed wanted to grow their exposure to alternative investments in 20218. This testifies to the rising importance of private asset classes as a way to generate higher returns and balance risk by diversifying portfolios.

  1. Preqin, 2021, The Past, Present and Future of the Industry
  2. Preqin, 2020, Future of Alternatives 2025: Private Equity AUM will top $9tn in 2025
  3. Preqin, 2021, Private Debt Fared Well During a Strained 2020
  4. S&P Global, 2020, Private debt to grow 11% annually to 2025, Preqin survey says
  5. Bain & Co, 2021, Global Private Equity Report
  6. McKinsey, 2020, In search of alpha: Updating the playbook for private equity in China
  7. Preqin, 2021, Private Debt
  8. Preqin, 2021, Preqin Investor Outlook: Alternative Assets H1 2021

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