Investors seek diversification in their portfolios for three important reasons: lowering portfolio volatility, reducing correlation between asset classes in which they are invested, and achieving better risk-adjusted returns. In previous decades, this would generally be accomplished through a traditional portfolio comprised of 60% equities and 40% bonds. However, as the public markets are becoming increasingly interconnected, investors must now look beyond stocks and bonds to achieve true diversification. Sightline Wealth Management builds portfolios by incorporating alternative investments to manage risk and correlation to traditional equity and bond markets without compromising portfolio performance. There are many types of alternative investments, each with its own benefits and risks. In this article, we break down the basics of investing in private equity.
Private equity is an investment in a private company, meaning a company that does not trade on any public markets such as the Toronto Stock Exchange. For years, managers of multi-billion-dollar pension and endowment funds have been investing significant portions of assets under management into private equity for several reasons, including:
- Low correlation to public markets, which provides diversification1
- The potential for better returns compared to publicly traded companies2
- Downside protection and even the opportunity to grow in value during a downturn3
- The opportunity to invest in businesses before their public value is realized
As markets become increasingly connected and diversification becomes more difficult to achieve, institutional investors have increased their allocation to alternatives in general and specifically private equity.
Source: Canada Pension Plan 2020 Annual Report
In 2004, the Canada Pension Plan allocated just 3% of its assets to private equity. In 2020, it allocated 61% of assets under management to alternatives with 25% allocated specifically to private equity.
Source: Canada Pension Plan 2020 Annual Report; Tiger 21 Q4 2020 Asset Allocation Report
Though there are multiple advantages with investing in private companies, like any other investment strategies, there are still challenges investors would face. The main challenges include liquidity, diversification and opportunity. Investing in private companies takes time, and in many cases, it takes years to get to any liquidity event or any dividends/income back to investors. Finding solid private companies also requires expertise and the right set of skills – specifically the ability to review and select business plans, projects and management that are worth backing with capital. It also requires a large amount of capital to achieve proper diversification into multiple companies. Finally, timing is important. We recommend private equity investors to have a pipeline of staggered liquidity events with multiple liquidity exits to access capital.
While private equity was seen as something only for the multi-billion-dollar institutions, it is now becoming increasingly accessible to individual investors who are working with an advisor. Sightline Wealth Management can help you find the right form and size investment to incorporate private equity into your portfolio – and because each investor’s situation is unique, we can help determine the right percentage to be allocated to private equity and how to choose certain positions over investing in one company to achieve maximum diversification.
1 Cambridge Associates, September 2019, “Managing a Portfolio Through Equity Market Downturns.”
2 Bloomberg Business Week, 2019, “Everything is Private Equity Now”
3 Shai Bernstein & Josh Lerner & Filippo Mezzanotti, 2019, “Private Equity and Financial Fragility During the Crisis.”
Sightline Wealth Management LP (“Sightline”) is an investment dealer and is a member of the Investment Industry Regulatory Organization of Canada (IIROC) and the Canadian Investor Protection Fund (CIPF). Sightline provides management and investment advisory services to high-net-worth individuals and institutional investors primarily through fee-based accounts.
Sightline Wealth Management LP is a wholly owned subsidiary of Ninepoint Financial Group Inc. (“NFG Inc.”). NFG Inc. is also the parent company of Ninepoint Partners LP, it is an investment fund manager and advisor and exempt market dealer. By virtue of the same parent company, Sightline is affiliated with Ninepoint Partners LP. Information and/or materials contained herein is for information purposes only and does not constitute an offer to sell or solicitation to purchase securities of any issuer or any portfolio managed by Sightline Wealth Management or Ninepoint Partners, including Ninepoint managed funds.
The opinions and information contained in this article are those of Sightline Wealth Management (“Sightline”) as of the date of this article and are subject to change without notice. Sightline endeavors to ensure that the content has been compiled from sources that we believe to be reliable. The information is not meant to be used as the primary basis of investment decisions and should not be constructed as advice. Each investor should obtain independent advice before making any investment decisions.