Verger’s Taylor Jackson, Investment Director, sat down to share insights on private investments and how they may be beneficial to a non-profit organization’s investment strategy. Watch the full video here (~5 mins) or read the transcript below.
What is a Private Investment?
A private investment is essentially an investment in an entity that is not publicly traded, whether that be a direct investment into a company or asset or through a commingled vehicle or fund. Today, we will focus on investments through a fund, which is an offering of unregistered securities to a limited pool of investors.
When making an investment in a private strategy, the investor or limited partner commits a dollar amount to a fund through the fund manager or general partner, usually invested over three to five years. The fund manager calls capital from the investors as they find investment opportunities.
These investments are illiquid, meaning that investors generally cannot receive any portion of their investment until the fund ultimately exits the underlying assets, typically a period of several years from the time of the initial investment. The intended outcome is to achieve a return in excess of what the investor could have received in the public markets, or what is commonly referred to as the “illiquidity premium”.
Pros of Private Investments for Non-Profits
- The potential to provide alpha versus public markets over the long run.
- Fund managers exert a high degree of control over the companies purchased for the fund, providing them with the opportunity to have an impact on creating value for that investment.
- Fund managers have the ability to determine the best market cycle timing for entering and exiting investments due to their long-term nature.
- Many private funds require that investors receive a minimum rate of return, net of fees, before the fund manager can receive an incentive fee.
- In many cases, the fund manager commits its own capital in the fund, ensuring its interests are aligned with the investors.
Cons of Private Investments for Non-Profits
- These investments are illiquid which means they are not freely traded.
- While many private fund managers are registered with the SEC, their underlying funds and strategies are not.
- Private funds and strategies provide audited financials; however, the valuations of the underlying assets are determined by the fund managers.
- Returns are also difficult to benchmark as private strategy reporting typically lags that of more liquid strategies. Given the long-term nature of these investments, measuring relative performance over shorter time periods does not accurately reflect their impact on a portfolio over the long-term.
- Investors are contractually obligated to invest with the fund for a period of typically ten years or more. During that time, they are required to periodically contribute capital within limited time frame, which may not necessarily coincide with an institution’s cash flow.
- Fees associated with private investments are generally higher than those of other assets classes, and given their structure, fees can be a drag on performance in the early years of the life of an investment, which is commonly referred to as the J-curve.
Why do Private Investments Make Sense for Non-Profits?
Private fund investments can be a good match for endowments or foundations since they have sufficient assets to qualify as well as the long-term investment horizon to make these investments feasible. An allocation to private strategies provides non-profits with a differentiated source of return when compared to more liquid strategies, as well as strong potential for alpha over public markets.
What Are the Key Considerations for Non-Profit Investors?
As with any investment opportunity, non-profits should start by assessing their needs and objectives. For private investments, in particular, it is important to understand an institution’s liquidity requirements and how much it is willing to have committed for prolonged periods of time. An organization must also determine the most appropriate structure to access these investments.
One approach is to hire a consultant or team to build out this part of your portfolio from scratch. Starting from the ground floor will require your institution to go through the J-curve that we mentioned earlier, which will result in a drag on returns, especially in the first few years. It will also take time to grow your allocation to the targeted amount and to the point when you will begin to see an impact from these strategies on your portfolio.
Another option is to invest in a portfolio of private strategies that are already in the ground. While you run the risk of dilution as new investors participate, buying into an existing portfolio provides the scale of a larger pool of assets and will help to mitigate that J-curve. And, because strategies that are already in the ground are more mature, the returns may be more meaningful to your portfolio earlier in the life of the investment.
Finally, a critical consideration is the network and relationships of the asset manager providing this exposure to your institution. Do they have the ability to access top private fund managers? The dispersion of returns among private strategy funds is very wide and missing out on the best managers could mean leaving a lot of money on the table.
Explore Verger’s insights on alternative investments, more broadly, and their potential benefits for non-profits.