Private equity is changing: what are alternatives for breaking into the private market?

Blackstone Group is in the final stretch of raising its eighth fund, which is going to be the largest Private Equity (PE) fund in history, capped at around $25 billion. Blackstone’s fund represents a changing trend in the PE industry — larger fund sizes. Although the funds are getting bigger, the returns have been insufficient, causing institutional investors to seek other ways to invest in the private market.

In the case of the Blackstone fund, general partners of Blackstone raised this fund amid high demand from numerous institutional investors, including sovereign-wealth funds, pension funds, and education institutions who have hundreds of millions of dollars to put to work.

Although the size of Blackstone’s recent fund was enormous, it’s not out of the ordinary. In actuality, it represents a prominent trend in private equity: megafunds. In fact, with Apollo’s 2017 $24.6 billion fund, Advent International’s 2019 $17.5 billion fund, and Vista Partner’s 2018 $16 billion fund, it’s easy to believe this trend is the new norm for PE.

Do Larger Funds Create More Value for Investors?

Even though PE funds have been getting larger, returns have not had a better performance. According to the Wall Street Journal, these megafunds have had subpar performances in recent years, earning returns barely above that of the S&P 500.

The S&P 500 posted a 14.1 percent return over the past five years, while PE funds over $10 billion posted a mere 14.4 percent return. According to WSJ, this phenomena — due to large funds having to target bigger, and less numerous, opportunities to deploy capital — has lessened the desirability of PE for institutional investors.

With a Changing Climate in Private Equity, What are the Alternatives?

The recent trends in the PE industry, coupled with substantial fees, limited optionality, and illiquidity, have prompted several institutional investors to circumnavigate PE funds and seek a direct role in private market trading. Institutional investors are doing this either through co-investments with PE firms or seeking private market transactions directly, highlighted in a February 2018 BCG Publication.

Given the rise of the pre-IPO securities trading, private markets are now becoming much more liquid for both retail and institutional investors, as discussed in a 2019 McKinsey Industry Primer. With this trend, IPO securities trading is becoming a realistic way for institutional investors to invest in private markets without going through PE funds. For example, BNP Paribas — a French investment bank that has offered private equity investments to its clients since 1998 — has collaborated with Forge to create a structured equity product in pre-IPO companies. The product is the first of its kind in the investment banking industry.

When discussing the BNP/Forge Partnership, CEO of Forge Kelly Rodriques stated, “We’re bringing cutting-edge financial products to market that provide investors unprecedented access to pre-IPO securities while presenting new options for private companies to raise money and control their financial future.” The announcement follows an increasingly global customer demand for investment opportunities in pre-IPO companies, and this partnership symbolizes the growing demand for institutional investments in Pre-IPO companies.

What About Smaller Private Equity Funds?

Granted, smaller PE funds have not faced such a drastic phenomena of sub-par performance compared to megafunds raised in recent years. Nonetheless, substantial fees, complete lack of optionality, unpredictability of capital calls, and the substantial illiquidity of PE is still drawing investors to alternative ways to invest in the private markets.

On the other hand, pre-IPO security trading through marketplaces, such as Forge, offers broad access to the private market, not constrained by opportunity sparsity faced by PE funds. What’s more, pre-IPO trading minimizes constraints present in the private equity industry, including illiquidity and unpredictability of capital calls.

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Investing in private company securities is not suitable for all investors. An investment in private company securities is highly speculative, involving a high degree of risk, and investors should be prepared to withstand a total loss of your investment. Private company securities are also highly illiquid and there is no guarantee that a market will develop for such securities. Each investment also carries its own specific risks and investors should conduct their own, independent due diligence regarding the investment, including obtaining additional information about the company, opinions, financial projections and legal or investment advice. Accordingly, investing in private company securities is appropriate only for those investors who can tolerate a high degree of risk and do not require a liquid investment. Past performance Is not indicative of future results.