Private Investments Aren't Safe From This Market

Editor's note: Volatility has rattled investors this year... And to many, it seems like the public markets have taken more than their fair share of the pain. But in this essay – updated from our October 25 edition – Director of Research Rob Spivey explains the misunderstood truth behind privately held investments.

Don't believe everything you read...

It's no secret the public markets are reeling. And personal investors' stomachs are in knots watching the volatility take its toll on their portfolios.

Inflation and poor market performance have folks concerned about their wealth. Many might not be able to meet their long-term goals as soon as they'd hoped.

But there's an entire category of investments that's doing just fine... Or so it seems.

Back in October, Bloomberg reported that investors with access to private investments were performing much better in 2022. That includes categories like hedge funds, private equity, and physical assets like real estate and infrastructure.

These investors have pushed a lot of money into private assets since the global financial crisis. Stocks have lost one-fifth of their value this year, while bonds have lost one-sixth. Private equity is set to outperform both in the next decade.

These asset classes are exclusive to accredited investors. In other words, everyday folks don't have access to them.

That probably feels frustrating, considering the S&P 500 is down about 20% this year. While most of us are in the trenches, these big investors appear to be avoiding the pain.

But as we'll explain today, private investments aren't magically better than public ones.

The truth is, private equity is just as susceptible to cyclical ups and downs...

It all comes down to something called "marking."

Asset prices change when there's a purchase or sale. That creates a new market price. Stocks "mark up" and "mark down" thousands of times per day.

The reason public investments look so bad is that you can follow the price changes from day to day. Your brokerage account shows you daily gains and losses.

Private investments like real estate and venture capital lack that volatility because they're not priced daily. Pricing requirements are a lot looser for these assets, and they typically take years to pay off.

This can disguise declines behind a large fund whose performance is only updated every quarter or every year.

It's not that private markets aren't cyclical like public ones. Rather, the general public is simply not aware of these funds' every move. Compare that with folks' ever-changing public portfolios, and you'll understand why private equity seems a lot more stable at first glance.

In fact, the moves can actually be bigger. Private-equity firms generally take on a lot of debt. This translates into more-risky investments. But that risk isn't disclosed to the general public.

These private companies can get away with giving up very little information...

They don't have to mark their assets down unless there's a sale.

For instance, you might recall that private-equity firm Thoma Bravo bought Anaplan back in April. It's likely that if Anaplan was still public, its stock would be hurting like the rest of the market. But because Thoma Bravo is a private company, it doesn't need to mark down Anaplan's value every day.

Real estate is another example. If a real estate investor bought a property at the peak, when interest rates were still low, that property would sell for less today. But the investor doesn't need to record the price every day – only when he sells the asset.

The lack of movement in private investments simply disguises the problem. Few private-equity investors are buying or selling right now because nobody wants their investments to get marked down.

Eventually, something needs to give. Some company out there will need to sell one of its investments. That will finally clue the public into the fact that private markets are just as bad as public ones.

At the end of the day, there's one key difference between private and public equities...

You don't see the value of private equities falling like you would if you looked at your brokerage statement.

And that leads us to a simple solution – don't check your brokerage statement.

It's tempting to look at what your portfolio is doing every time the market is up or down. But the less you look, the easier it is to avoid panic selling.

It tends to hurt more to lose than it feels good to win... so it's best to spend less time looking at the numbers on the bad days.

As we often say, you shouldn't need to touch any money in your brokerage account for 10-plus years. You're in it for the long haul. So while it might be tough, remind yourself that the market falling in the short term should be of little concern to you.

Regards,

Rob Spivey
December 29, 2022