Why Private Capital?

This article is featured in our Private Capital Guide. 

Why Private Capital?

For families of significant wealth with portfolios concentrated in public markets, private markets provide potential opportunities for excess return and diversification.

In the public market, returns are based on a framework where shareholders own a small percentage of a company in a competitive and efficient marketplace. We see public markets as the equivalent of buying wine at the grocery store. Anyone can walk into the grocery store and pick up an average bottle of red wine — just like anyone can purchase the S&P 500 and expect to receive an average of a 4% return over inflation in the long run. Private markets, on the other hand, are accessible only through collaboration with experts. They require shareholders to pay a higher price for the opportunity to achieve greater results. Here, investors with specific preferences and additional resources can access top-echelon opportunities. Many people are content with investing only in the S&P 500. In fact, it is a solid plan for people who wish to grow their assets over a lifetime and do not have the flexibility to take on some illiquidity. However, as a person with significant means and the desire to preserve and grow your wealth for generations, it may make sense for you to have a more thoughtfully crafted, bespoke portfolio designed with both public and private exposure — accepting some illiquidity for the opportunity to experience excess returns and diversification over the long-term.

Establishing a private capital program is a long-term investment strategy for future generations.

How does private capital offer these advantages?

The private market provides control, expanded opportunity, and private market premium.

CONTROL

Investors typically have less control over investments in the public market and more control in the  private market.

Public: Public market shares trade at what the public believes is fair market value. Investors can easily buy and sell shares as desired, so a negative perception of the company can precipitate a drop in share prices. CEOs of public companies must report quarterly earnings to the public. Sensitive to public scrutiny, they typically avoid shortterm unprofitable ventures that could help their company achieve longer-term profitability.

Private: Investors generally enter the private marketplace through direct deals or a private capital firm, which seeks to invest in companies, fuel growth, make improvements, and sell its stake to turn a profit over a long-term time frame. The stake is typically 20–100% of a company’s worth, which means the PC firm can influence decisions in the company without worrying about the structures in public companies that can slow change — such as reporting quarterly earnings or needing to gain board votes to enact its plan.

EXPANDED OPPORTUNITY

Most investors utilize the public market as an alternative to cash holdings. The private market is an additional avenue for families of significant means to protect and grow their wealth.

Public: The public market refers to publicly listed companies, of which there are roughly 3,000 in the United States. Investment in specific companies enables the concentration of assets and the potential for modest returns over time, and index funds allow investors to capture broad market returns over time.  

Private: Wealth is created with concentration, and it is protected through diversification. With primary investment in a business, wealth creators must take care to diversify their portfolios around that exposure. Private capital provides access to opportunities outside of public markets, enabling diversification of return sources. There are about 200,000 small businesses in the United States alone, so managers can be selective and face  less competition when looking for companies to invest in.

Case Study:

An example of this is a private investment in infrastructure. While an investor can purchase listed shares of a solar company, the investment is exposed mainly to manufacturing of solar panels along with the management of the business. In the private markets, investors can invest in solar fields and be exposed to the cash flows of the power generation and value increase of the land. This is a diversifying stream of returns versus the public equity of the solar company. Diversifying the make-up of total return becomes much more impactful within private markets. An example of this would be investing in real estate. The spectrum of real estate ranges from core, which are prime buildings in gateway markets, to opportunistic, which can be halfvacant apartments needing work. While both are investments in real estate, the different risks cause them to carry a different return profile. Core buildings can return 6–8% a year with over half the return coming from yield. Opportunistic can return 12–15% total return, with the majority of it coming from capital appreciation.

Private Market Premium

Increased control and expanded opportunity in private markets means investors take concentrated bets on specific companies and firms. This additional risk can create excess return — the private market premium.

How can you navigate the downsides of Private Capital?

To access the private market premium, investors must be willing to accept some downsides.  At Balentine, we’ve built our program to optimize the trade-off between returns and drawbacks.

COMPLEXITY

The partnerships that are needed to access private capital come with much more paperwork and more complex tax reporting than purchasing an investment from the public markets.

Balentine’s Approach: We strive to minimize inconvenience to our clients and reduce potential human error by utilizing technology platforms to manage paperwork.

ILLIQUIDITY

Private capital investments require some illiquidity — managers might need years to make operational improvements that will net a premium for investors. To capture the premium, investors must be willing to part with their invested funds  for a period of time.

Balentine’s Approach: We are conservative  on the amount of private capital recommended for portfolios. Through rigorous scenario analysis, we determine the maximum amount of illiquidity a client should take based on the spending rate of their portfolio. The higher the spend rate, the less illiquidity we recommend.

ACCESS

Investing in the best managers can come with high minimums and limited access. Individual investors want direct access to companies with the next generation of new ideas but do not likely have the purchasing power to make a meaningful investment in that company or fund.

Balentine’s Approach: We use our  experience and size to negotiate favorable terms to access managers at minimums that allow investors to right-size the investment in their portfolio. In places where we cannot negotiate down the minimum, we build internal partnerships and pool our clients’ money to access these managers at scale. We do not take any additional profit from these partnerships, seeking only to cover their cost.

FEES

Fees are higher in the private markets than they are in the public markets.

Balentine’s Approach: We ensure fee structures for our recommended funds align the manager with our clients’ outcome, steering clear of managers trying to aggregate assets and live off the management fee. When  possible, we negotiate lower-than-stated fees and pass those savings through to our clients.

Case Study: Decarbonization

Over the next generation, we believe the decarbonization of our energy infrastructure could provide tailwinds for investors [1]. Seeking to help our clients access this opportunity, we created the fund Decarbonization 2022. This internal partnership pooled client assets and committed those assets to three managers we believed were best-in-class and focused on transitioning high-carbon businesses and processes to low-carbon, building small-scale solar fields, and investing in the next generation  of carbon-reducing technology.

Decarbonization 2022 has three distinct benefits for our clients:

1. Access. High minimums are common in institutional-level managers — for example, if a client  had tried to access these three managers on their own, they would have had to commit a minimum  of $20 million. Pooling assets together in one fund allows Balentine clients to benefit from  institutional-level investments without paying an institutional price tag.
2. Right-Sized Investments. Each client has a unique investment portfolio, including custom  liquidity constraints. We created a low minimum for Decarbonization 2022 to ensure that even with  this diversity of needs, each client could customize the size of their investment to serve their overall  portfolio strategy.
3. Reduced Complexity. Instead of one set of documents for each manager — including  account opening documents, capital calls, and tax reporting — investors receive only one set for  Decarbonization 2022. We seek to ensure our clients enjoy as much of the return as possible, so we don’t take additional  profit through additional management fees. The only cost to our investors is the fund’s operational cost.

We seek to ensure our clients enjoy as much of the return as possible, so we don’t take additional profit through additional management fees. The only cost to our investors is the fund’s operational cost.

Your Private Capital Guide

Now that you’ve entered the world of private capital, you may wonder where to start. How do you determine a reasonable level of liquidity? Then, how do you decide where to invest? With decades of expertise in this field, we strive to provide our clients with a custom private capital experience reminiscent of drinking a bottle of Burgundy sourced directly from vineyards in France — rather than picking up a bottle of red from the grocery store. At Balentine, we view private capital as a critical element for most intergenerational families’  long-term wealth strategies, and we develop customized, boutique private capital offerings to  support families for generations.

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[1] Read more about Decarbonization, one of our Intergenerational Investing Themes, here.

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