Investing was much easier when I wasn’t overly focused on the public markets and the day-to-day moves of the Federal Reserve.
You could say that things are a lot calmer when you’re focused on the long-term in a place where most retail investors don’t operate.
For the last decade, one of my focuses has centered on the alternative investment industry. I’ve worked as a consultant, journalist, and investor.
Now some of you might be asking, “Alternative investment industry?”
I want to discuss the importance of this industry and show you how you can get started in this business yourself. We’ll then discuss how private equity works and how you can participate in this critical investment class.
Understanding Alternatives
When considering alternative investment strategies, we focus on assets outside the traditional equity and bond markets. These investments have several characteristics you might not find in a stock like Coca-Cola, for example.
They might be less liquid, meaning there are fewer buyers and sellers. When this exists, assigning a specific value to these assets daily can be difficult.
Some of these investments have different legal structures. They might require specialized knowledge or a different approach to asset valuation.
These strategies largely act as a form of diversification and attempt to create market-beating returns outside traditional asset classes.
There are six common asset classes associated with the alternative investment world.
They include: Hedge funds, private equity, real estate, infrastructure, commodities, and art & collectibles.
Today, I want to focus on one specific alternative class. That’s private equity.
Explaining Private Equity
Understanding private equity is easier than you think. Most people believe this is a rich club exclusively allocated toward wealthy individuals and shuts out most ordinary investors. That’s partially true but not entirely accurate.
Private equity is a type of investment where people pool money together and allow a firm to control the decisions around their assets for a fixed period.
There’s no shortage of private equity strategies. However, one of the most common is the effort by a PE firm to purchase a company, restructure it, boost its profitability and cash flows, and then sell the company for a higher profit in the future.
Because this process might take a long time, private equity funds may have a lockup period of five years, seven or even up to a decade, depending on the strategy.
To better understand private equity, let’s look at how PE works.
First, private equity companies raise capital from institutional investors to create a fund. Investors include college endowments, pension funds, and accredited investors.
The latter group comprises investors who meet a specific annual income or net worth threshold.
Funds are typically structured as a partnership, with the investors acting as limited partners. This investment structure starkly differs from the traditional equity ownership for public company shareholders.
Second, as the private equity company starts to build its fund capital, it begins the process of analyzing potential takeover targets.
The fund might target a business that is underperforming, undervalued, or needing restructuring. This management process requires strategic change in the company’s business. The PE firm might change leadership, alter the supply chains, reduce costs across various divisions, or prioritize other operations that might make the company more valuable in the future.
A restructuring can take time. But once the private equity team has reached its objectives, it will explore a potential sale of the business.
They will typically exit their investment through an initial public offering (IPO), a direct sale to another company, or a potential merger with a business aligned with its objectives.
Following a sale, the PE firm will distribute its gains to the investors while taking its cut for managing the fund.
Private Equity for Public Investors
The current banking crisis and the shakiness of the public markets have created significant opportunities ahead for private equity firms.
These managers aren’t focused on the short term. They aren’t worried about the state of the economy over the next 18 months.
Instead, they are looking for struggling businesses or undervalued opportunities. They will scoop up private and public companies in the months ahead and look for a 100% to 200% return on their money on a five- to seven-year outlook.
One final question worth exploring is your ability to invest in private equity.
Can You Invest in Private Equity Today?
As I noted, direct PE investment is typically limited to accredited investors.
This is defined as an individual investor with a net worth of at least $1 million (excluding the value of their primary residence) or a person whose annual income sits at $200,000 or more (or $300,000 jointly with their spouse) for the past two years.
A few exceptions exist to the accreditation rules. Several private equity companies provide funds that are exempt from SEC mandates under Regulation D, Rule 506(b) or 506(c) of the Securities Act of 1933.
While non-accredited investors may be able to access these funds, they will attract some scrutiny and will likely need to meet a variety of other financial compliance rules.
While direct PE investment might not be possible, a more passive form is available to traditional investors. Several of the world’s top private equity firms trade publicly.
For example, Apollo Global Management (APO), KKR Inc. (KKR), and Blackstone Group (BX) all trade publicly on the New York Stock Exchange.
During the COVID crisis in 2020, KKR fell from more than $33 per share to just under $15. Three years later, the stock trades at $51.51, about 16% lower than its one-year high.
KKR is a name that investors should know. I’ll dive deeper into its operations, history, and unique upside on the backside of 2023 and beyond.
Private equity is a great addition to your portfolio. Understanding how private equity works is the first step to your long-term success.
To your wealth,
Garrett Baldwin
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