A Q&A with Chris Schelling, Managing Director of Private Markets
In a nutshell, what’s the difference between private investment opportunities versus public markets?
At the highest level, investing in private markets is no different than investing in public markets. You are owning securities, whether it be debt or equity, in a business, but that business isn’t publicly traded.
Most businesses out there aren’t publicly traded. There are about 4,500 public stocks in the United States, and there are 7 million companies that have at least one employee, according to the U.S. Census Bureau. By that number, the vast majority of businesses in the country are not publicly traded, and by gross domestic product, it’s well over half of our GDP.
By not exploring private markets, you are missing out on a lot of opportunity. I should also note that private equity is harder to access than public equity, which, by definition, can be owned by anyone. There are regulatory restrictions around who can participate in private equity that limit access to ultra-high-net-worth individuals and larger institutions. But that is changing.
What are the various methods of investing in private markets?
When we think of private markets, we divide the world into three parts: private equity and venture capital, private credit, and real assets.
Private equity funds are pooled investment vehicles that acquire equity stakes in private companies. Investors commit capital to the fund, which typically invests in companies for a handful of years before exiting through a sale, IPO, or other means. Venture capital funds are similar to private equity but focus on early-stage startups or growth companies.
Private credit investing is the method of providing loans or credit to companies or projects that are not funded through traditional bank loans or public markets. In a low-interest environment, this type of investment can be a boon to a portfolio.
Then you have real assets, or real estate, which are private investments into hard assets like property or infrastructure and are often a lot more tax efficient because of accelerated depreciation and other types of tax benefits. Because of this, private market investors will often have a large allocation to real estate.
What are the primary benefits of investing in private markets?
Most investors don’t need large-cap equities. They don’t need high-yield bonds, per se. What they need is capital appreciation. They need income and diversification. These are the building blocks of any strong investment portfolio.
Private markets can provide an opportunity for more capital appreciation and more income than what you get in publicly available counterparts. If you invest in private equity, it should beat the stock market. If you invest in private credit, it should beat public bonds.
A lot of innovation happens in private markets. It’s when the big public companies wind up acquiring them, or they go public, that you see growth slowing. Growth is mostly happening in the private markets. They are typically growing faster, and that’s what you want if you seek capital appreciation. What you give up for that is liquidity. So, investors need to be thinking through how much of their portfolio they need to have access to month-to-month and shouldn’t invest in private markets beyond that.
What are the common misperceptions about private market investing?
The idea of risk in private market investments is misunderstood. In public stocks, we think about the volatility—how much stocks oscillate as they trade over time. Volatility in the context of private markets is almost irrelevant—the relevant risk is liquidity. The risk is not being able to access or sell an asset for many years at a time, or to only do so at a significant discount.
There’s a perception that private market investing always leads to higher returns without the associated risks. This is untrue. While private market investing can offer appealing returns, there are significant risks, such as illiquidity or a business you are invested in failing. Another myth is that everyone should have private equity and private credit in their portfolio. The truth is private equity and private credit might not meet your liquidity needs. It’s also a myth that private equity is entirely inaccessible to most investors. While that may be true directly, by aggregating client capital, advisors like Caprock can create exposure to best-in-class managers that would have historically only been available to large institutions using single-asset Special Purpose Vehicles (SPVs) and commingled limited partnership structures.
What are common pitfalls to avoid when investing in private markets?
One thing to know about investing in businesses that are not publicly traded is that there’s not as much information available on them. Their financial information and how they report it is not overseen by a regulator like the SEC, so there’s a lot of variability. It’s critical that your advisor does an extreme level of due diligence before committing to a private market investment. There is a very big difference between an advisor who looks at 40 funds before selecting an option for clients and one who investigates 400 funds. In any given year, Caprock is taking meetings with well north of 500 unique private market funds to invest in 15 to 20.
If mistakes are made when investing in private markets, it’s difficult to unwind them because it’s an illiquid asset class. Think of it like buying a house. If you purchased a house in a bad neighborhood, that’s a difficult investment to undo.
Since liquidity is the most significant risk in private markets—once allocated, it will take years to realize a full return on money—it is vital to plan your target allocation carefully.
Working with an advisor who can help establish a prudent liquidity budget and a reasonable pacing plan can help investors avoid getting into a situation where they are overcommitted and face a liquidity crunch down the road.
One of the benefits of being an independent advisor is an open architecture platform. Advisors like Caprock can access virtually any private market fund or manager in the world and can focus on the opportunities that present the best risk-adjusted return. Other business models, such as the big bank platforms, have conflicting business lines and internal products where hidden fees and commissions can often trump finding the best opportunities for clients.
How can people start investing in private markets?
It begins with liquidity budgeting and a pacing plan in the context of your overall balance sheet considerations and asset allocation relative to your investment objectives. Figuring out how much capital appreciation, income and liquidity you need is key. Speak with an experienced advisor about your goals and opportunities in private market investing.
At Caprock, we have a diverse team with deep expertise in private investment asset classes. We have invested more than $4.8 billion in private markets on behalf of our clients across 440 investments. With more than 20 years of experience in investing in private markets, Caprock’s team of six dedicated private markets investment professionals is happy to answer any questions you may have.
About the Author
Chris Schelling is the Managing Director of Private Markets at Caprock. He is an investor, advisor and published author. With degrees in psychology, business, and finance, Chris is an expert at incorporating insights from behavioral finance into investment decision-making. During his 20+ year tenure in the investment industry building portfolios, mostly focused on alternatives, Chris has met with over 3,500 managers and allocated roughly $7 billion, generating top quartile to top decile returns across hedge funds, real assets, private credit, and private equity.
©Caprock. All rights reserved. The Caprock Group, LLC (“Caprock”) is an SEC Registered Investment Advisor. This communication is not an offer or solicitation with respect to the purchase or sale of any security and is for informational purposes only. Information contained herein has been derived from sources believed to be reliable, but Caprock makes no representations as to its accuracy or completeness. Investment in securities involves the risk of loss. Past performance is no guarantee of future returns. Registration with the SEC does not imply a certain level of skill or training.
