So, what about listed assets ?

We have received some feedback that our articles only highlight the advantages of PE, while in the introduction, we stated that it was not really a competition between PE and public equities...

This is true, but we needed to start with the asset class that is closer to our heart ;-)

In essence, PE investments, if made by professional and experienced (and to some extent lucky) investors, have a number of advantages:

* Better access to information, which means a better chance of making an informed investment decision.

* Better information during the monitoring phase, which allows for greater agility and the ability to influence necessary changes. It also allows for the pooling of expertise and experience to help overcome problems.

* More importantly, the interests of all stakeholders are usually aligned, which eliminates noise and allows for a focus on value creation as the only objective.

These are quite significant advantages that PE has over public equities. However, public equities have two fundamental advantages in comparison to PE: liquidity and external valuation.

Private Equity is a long-term game. A fund is raised, then deployed over a period of three to five years, and then the portfolio is realized. Once proceeds come from exits, they are returned to the LPs, with a standard waterfall: the cost is redeemed first, then a preferred return is paid to the investor (the "hurdle"), and then an incentive is paid to the team, the carried interest, which is usually 20% of all capital gains made. Once the hurdle is paid to the investors, the team has a preferred return, the "catch-up," that pays 20% of the hurdle first, in order to equalize the positions between the team and the investor. After this, all proceeds are shared on a 80/20 basis between investors and the investment team. All in all, this process can last ten to twelve years. An investor in a good fund usually recovers his investment in five to seven years, but the total liquidation of the fund can take longer. In summary, Private Equity is not suitable for investors who may need to use these funds in the short term. Exiting a fund commitment means selling the position in a secondary market, which can be illiquid and usually requires significant discounts. This can result in a loss for the initial investor. That is why this asset class is usually populated by institutional investors who have time, such as pension plans and insurers. And that is the main risk, especially if the asset class is widely opened to individual investors who may not "read the fine print" and end up stuck or forced to sell at a loss. Listed equities, of course, do not have such constraints. You can enter and exit whenever it suits you, when you deem the gain sufficient, or when you consider the loss to be too heavy.

The second element is that the "market" provides a valuation of your investment, whether it is right or wrong, precise or approximate. The continuous pricing provides you with an external reference as to what your investment is worth. In PE, there are usually quarterly valuations of each portfolio line, but they are performed by the fund's team and subject to a strong element of judgment, which can be a risk for the investor. PE valuation can be seen as "black magic" mixed with the statement of a former French President: "promises only engage those who believe in them." The final buyer of the asset and the price they are willing to pay several years down the road is the only judge of peace. In the meantime, you have no way to judge. On the stock exchange, supply and demand meet at a given price constantly. Another element of discomfort is that your liquidity on the secondary market is dependent on this valuation. A secondary fund will offer you "Net Asset Value less a discount" (there have been slight premiums in the past for top performers or those recognized to systematically undervalue their NAV, but these cases are not the norm). But the NAV depends on subjective valuation. Therefore, if you need liquidity at all costs, you have a double risk of negative financial impact.

So the market is more liquid and prices "better" (for lack of a better word) given that it contains thousands of participants at any given moment. But there is a last fundamental difference, which has no direct impact on comparative performance: In public equities, you invest in companies; in private equity, you invest in a team that then deploys your capital in a discretionary manner. While you can evaluate a listed company based on information, you evaluate a fund based on its past performance (which does not guarantee future gains), its team, and its strategy. These soft elements can make investors uncomfortable because they have to trust a third party to make money for them.

In the end, as mentioned in the introduction, there is no clear winner. If you have the means and the patience, you should definitely invest in both categories. Indeed, PE has outperformed large public indices, but single companies have outperformed or underperformed such "average" returns, both in public and private markets. Both types of investment are complementary:

• PE controls the investments and is closer to the companies, which allows it to drive the development of the asset. This comes with a responsibility: the money it manages needs to produce a capital gain, and such a capital gain needs time to be realized. In the meantime, you can only wait. You also need to have deep confidence in the PE team to handle the asset correctly; you have no influence at all.

• Stock owners in public markets do not control the asset they own and are quite far from the decision-making process. However, they have directly chosen the company they want to invest in. But if they are wrong, they only have the ability to "vote with their feet" and sell the shares. But they can do this whenever they want or need to, and the market gives them an objective price.

Private Equity is more and more in the spotlight due to the listings of PE funds over the last decade and the growing trend to push the "retailization" of PE. But it is not the same than investing in a public company. Even if we deeply believe that any sizeable portfolio should contain an allocation to PE, it is important to be aware of the pitfalls, the landscape, the different sub-classes of PE funds and strategies, and to have good access to information about this still quite discreet asset class. Many players pushing funds today are pushing the ones they have on the shelf to investors attracted by the "PE fashion." This can lead to disappointments.

The next series of posts will go further into details regarding the landscape of players, the strategies and the principles for a solid and diversified PE allocation. Our purpose is not to name recommended players but to allow you, if you keep reading, to be informed about the basic principles, the risks, and the significant upsides that exist.

We hope you found this first series interesting. Please provide feedback on Linkedin or write to contact@korafin.com.