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How Is Private Equity Different From Public Equity?

Investing in equity means owning a portion of a company. Private equity versus public equity refers to how the shares are traded and who may be eligible to purchase them. Many investors are more familiar with public equity, which is traded on a public exchange. Private equity cannot be sold on an exchange. In many cases, investors must meet certain qualifications in order to purchase it. 

All equity is not created equally. There are major differences in the way private and public equities are purchased, held, and sold. They require different investment strategies and play separate roles in a balanced portfolio.

Public Equity

If a company decides to "go public," they may hire an underwriter to evaluate the offering and to set the expected price of the stock.  This stock will be offered to investors once it is priced.  After it is priced, it is then listed on an exchange so that anyone may purchase the shares. The offering is priced based upon the value of the offering and how much interest the offering is likely to attract from both individual and institutional investors. After the stock officially opens on an exchange, the shares are free to trade and the price will fluctuate based on many factors, including supply and demand.

When corporations are publicly traded, they are required to make quarterly filings with the Securities and Exchange Commission. The company must publicly disclose its financial condition. If a company fails to accurately report their financial information, they could be misleading their shareholders, which the SEC takes very seriously. 

Private Equity

Private equity is a much more restrictive type of investment. When a company wants to raise money but cannot or does not want to go public, they may choose to offer private equity to qualified investors which is strictly defined by the SEC For example, your friend from college launched a start-up and they are raising funds. You could invest some of your money into their business in exchange for a specified portion of the ownership. If the start-up fails, you may lose all of the money you invested. But if the company is successful, your investment may be worth more than the amount you originally invested.

Private companies do not have to release their financial information to the public, only to their investors. 

Making Shareholders Happy

Another difference between private and public equity is the amount of people the leadership of the corporation needs to please. A private company usually has a smaller number of people who are shareholders and tend to have a desire to see the company grow exponentially. Private equity investors are sometimes less interested in an immediate return on their investment purchase and more interested in seeing it grow over time.

Public companies, on the other hand, usually have a much larger pool of shareholders who may put pressure on leadership to see a current return on their investment. This often means making decisions between what will be best for the investors and what will be best for the company. For example, a company might decide to release a dividend to please the shareholders instead of investing that money back into innovation which could make the company more profitable in the future.

Public Vs. Private Equity

It is a common misconception to assume that all large companies are publicly-traded while all small companies are private. A corporation can also decide that it no longer wishes to be publicly traded. In other cases, companies become private after being acquired.

Public equity is more liquid than private equity and is available to anyone who wants to purchase shares. The two types of assets are managed with different strategies and target different investor goals and objectives.

How To Assess the Liquidity Of An Asset

The liquidity of an asset refers to how quickly it can be converted into cash. For example, a $10,000 money market account (“MMA”) is more liquid than a rare coin collection valued at $10,000. If you wanted to take your money out of the MMA, it is simple to make a withdrawal or close the account. However, if you wanted to sell your rare coin collection, you would have to find people who would be interested in paying $10,000 for it and make a sale yourself, which could take time waiting for the right buyer to come along.

Before you make an investment, it is important to understand the asset's liquidity. If money gets tight and you feel pressure to sell the asset down the road, you may not find a buyer willing to pay full price when you need the funds. This could lead to selling the asset at a loss. The good news is that there are some simple questions to ask to determine how liquid an asset is.

Is the asset simple or complicated?

Some assets are reasonably simple to understand. Buying a house, for example, is a straightforward process. Sure, there is a lot of paperwork and moving pieces; but at the end of the day, money is exchanged for ownership of property. Buying a mortgage-backed security, on the other hand, is an investment that uses one or more mortgages as the collateral backing the asset. That is a much more complicated investment that may be more difficult for the layperson to understand. The complicated assets however, is more liquid.

What is the price momentum of the asset?

Price momentum refers to how quickly the asset changes in value. When the value of assets begins to rise quickly, the market may become more volatile as investors adjust their strategies. If the price momentum of an asset is going up, it could be a sign that the liquidity is going down.

These are just a few of the ways to determine how liquid an asset may be. An illiquid asset is not inherently a bad thing to invest your money in. However, it is important to have a greater understanding of how illiquid investments fit into a balanced overall portfolio.

International Investing

The wide range of investment products available in the United States can be overwhelming to new investors. But at some point, in building a portfolio, every investor’s eyes start to wander to other financial markets all over the world.

One of the main reasons that people invest internationally is that it spreads out their investments across different markets, increasing their diversification. This makes it less likely that a financial catastrophe in one market will ripple through your entire portfolio. But another reason international markets are attractive is because some have room to grow, which could mean a higher potential return.

Of course, the higher potential return is never without risk in the investment world. For this reason, it is important to consider that the entire range of asset classes are available in outside markets. All of the same investment strategies and diversification principles still apply, which means you must carefully consider asset allocation and your overall investment strategy.

Investment Options in International Markets

  • International Equity (Stock)

Companies in the United States use equity to raise money and innovate or grow their business. There are companies all over the world looking to do the same which might add value to your portfolio. Expanding equity investments beyond our borders can help you find the right companies to invest in, no matter where they are located in the world.

  • International Government Debt (Bonds)

Governments raise money through bonds and other notes. Developed economies like the United States tend to offer more stable bonds. But emerging and frontier markets need time to grow and develop, making them potentially more volatile. That is where third-party credit rating agencies come into play. Just as bonds are given credit ratings that give investors an idea of how stable the investment is, countries earn ratings as well. It is important to pay attention to the credit worthiness of any country you are considering purchasing bonds in.

  • International Indexes (Funds)

Investing in international mutual funds may give your portfolio exposure to different markets and industries at the same time. Much like domestic mutual funds, the main advantage is broad market exposure.

Economic Development

No stable market is born overnight. Countries (and their markets) are classified as either developed, emerging, or frontier. A developed country like the United States has a mature economy, which is therefore may be easier to predict. The market is constantly in motion and influenced by countless factors, but all of the factors are in place.

In emerging and frontier markets, the economies are younger. The infrastructure to support mature economic growth might still be in the development stages, and the major players have not necessarily been established. These unpredictable markets should be carefully evaluated, but might appeal to investors looking to diversify their aggressive investments.

Maximize Investing on a Budget

Investing money for the future is important, but it can be difficult to find money to set aside when budgets are tight. There are three main strategies to use to maximize the money you have available to invest without overspending: investing small amounts at a time, choosing an appropriate investment, and investing in your ability to invest.

Saving Small Amounts of Money at a Time

Every time you save money, you are making progress towards a future goal. This is true whether you save a large amount of money or a small one.

Some financial institutions offer programs to help you save money, for example, a program that rounds up every transaction to the nearest dollar and deposits the difference into a savings account. With mobile app technology, financial organizations are increasing the access that small investors have. Apps like Acorn, Stash, and Robinhood allow individual investors to run their own portfolios for as little as the price of one share of stock.

If you choose to use an app to help you save small amounts of money, take the time to research which financial institutions run the app and examine any potential conflicts of interest. Also make sure that your information and account is password protected. It is also important to remember that these apps may offer investing advice, but ultimately are not responsible for the returns or losses in your portfolio.

Choosing an Appropriate Investment

When your investment is small, it becomes more important to avoid fees and other expenses.

Look for investments with low expense ratios, like passively-managed mutual funds or Exchange Traded Funds (“ETF”).

Another advantage to mutual funds or ETFs is they offer broad market exposure. This spreads out the risk among multiple companies. There are many different types of funds that have built-in diversification so investors with a smaller amount of money can diversify their holdings.

Some options, like a target-date fund, automatically adjust the investment strategy as time gets closer to the target date. For example, a target-date retirement fund begins with a more aggressive strategy, and becomes more conservative to preserve the money in the account as retirement age gets closer. There is no guarantee that the fund will meet the targeted objectives.

Investing in your Investing Ability

If you do not have a lot of money to invest in your retirement right now, invest instead in solutions that may increase your investing power. What steps could you take right now to increase your income, lower your monthly payments, and make your budget less tight in general?

Maybe instead of investing and saving small amounts of money, you could put that money towards part-time classes to enhance your career skills. Depending on where you live and what your industry is, it is possible moving to a different city or state would help you find a better-paying job or a lower cost of living?

If you have too many monthly payments, consider investing your money into paying off your existing debts.  Once you have reduced your monthly payments, you may have more money at your disposal to invest in your retirement account.

These steps may not look like investing the way we traditionally think about it, but they are still strategic moves you can make that will increase your ability to save money in the future. It is an investment in your own ability to invest.

What are Corporate Bonds?

A corporate bond is a way for investors to loan money to companies. A company will pay interest to bondholders regularly over a set period of time. When the bond matures, the company will repay the bondholder the full-face value of the bond. Corporate bonds are similar to government bonds in structure, but tend to offer higher coupon payments because are usually considered higher risk than a bond issued by the US Government.   

The bond itself is usually secured either by the company’s revenue or their assets. For example, a well-established company with a proven ability to bring in a steady revenue stream can offer attractive bond coupons and a measure of security to investors compared to a brand-new company with an unproven ability to earn money. 

Corporate Bonds versus Stocks

Corporate bonds and stocks are both used as a way for a company to raise capital. But stocks represent equity in the company, or ownership. This means if the value of the company rises or falls dramatically, so will the value of your asset. Stocks may offer a dividend, but are not required to.

A corporate bond, on the other hand, usually has a more stable value having less to do with how well the asset is performing and more to do with the demand for bonds. If all goes well, the bondholder will earn a constant return on their investment, even if the company’s stock triples in value. If all does not go well and the company goes bankrupt, bondholders have some protections under bankruptcy law and have a legal claim to be paid. However, this can take time and bond holders do not always get all of their investment back.

Corporate bonds are often used as a more predictable and stable balance to more volatile assets like stocks.

Bond Maturity and Rating

Corporate bonds offer interest payments for a set length of time, such as one year, five years, or ten years. After that period, the initial investment will be returned in addition to the last interest payment. In some cases, investors can redeem or sell their bonds early.

Often investors are not directly purchasing bonds, but investing in bond-based mutual funds. These investments may offer a steady dividend in the form of interest payments and fluctuate in value based the current interest rates. A fund of many different bonds lowers the chance of losing money even further by spreading out the expectation of return.

Another way that corporate bonds differ from one another is in how the bond is rated. Credit agencies calculate the chances that a bond will be defaulted on and assign a corresponding rating. An investment-grade bond has a lower chance of going into default, while lower rated bonds usually have a higher chance.

 The highest bond rating is AAA, which is considered prime investment grade bond. High grade (but not prime) investment bonds are those with ratings of AA+, AA, and AA-. Medium grade bonds rate at A+, A, and A-. The ratings continue through B, C, and D in the same manner, creating 20 different total ratings.

Bankruptcy

There are special rules about what happens to bonds when a company files bankruptcy. Bondholders, like all of the company’s other creditors, will have a chance to file a claim in the proceedings. Many bonds list in the terms exactly where a bondholder’s claim will sit if the company ever were to file bankruptcy, and this order of priority will also depend on the type of bond. If a bond were secured by company owned property, such as equipment or real estate, the bondholders could pursue seizing those assets.

These features of a bond offer some measure of security against losing money on your investment.

Corporate Bonds

Any company can offer bonds, whether or not they have a solid business plan and leadership. Like any other asset, it is important to perform due diligence before purchasing bonds. However, bonds are usually not as volatile as stocks and offer regular interest payments.