CLOSE

Private Market Inefficiency: What It Is and How to Exploit It

By: Gridline Team | Published: 09/13/2022
 | 
Est. Reading Time:
3 minutes

The efficient market hypothesis (EMH) posits that the stock market incorporates all available information about future values due to competition, free entry, and low information and trading costs. This results in all stocks pricing at their "correct" value, as determined by future cash flows.

The EMH commonly argues that it's impossible to beat the market since all publicly available information is already reflected in stock prices. But those drivers of public market efficiency don't necessarily apply to private markets. In private markets, there are often large, inefficiently priced gaps between the current value of a company and its future potential value.

In this article, we'll discuss why private markets are less efficient than public markets, how this inefficiency creates an opportunity for alpha creation, and why selecting the right managers is essential to capturing that opportunity.

Why private markets are less efficient than public markets

There are several reasons private markets are less efficient. First, there's much less competition in private markets. Fewer investors are interested in buying stakes in privately held companies than in publicly traded companies.

Second, entry into private markets is often restricted. Investors must meet certain criteria to be eligible to invest in a particular company (such as accredited investors status or high capital minimums). This lack of competition preserves existing pricing inaccuracies. 

Finally, information asymmetry is more prevalent in private markets. Private companies are not required to disclose as much information as public companies, so it's often difficult for investors to assess the true value of a private company. This leaves room for mistakes to be made in valuation.

These factors contribute to a general lack of efficiency in private markets. In other words, there are often large gaps between the current value of a company and its future potential value. This creates opportunities for skilled investors to generate alpha by identifying these mispriced assets and investing accordingly.

Inefficiency creates opportunity for alpha creation

Fund managers don't just generate alpha by taking on a liquidity premium; they also generate alpha by being more skilled than their peers at identifying mispriced assets.

In private markets, there are often large inefficiencies between the current value of a company and its future potential value. This creates opportunities for trained investment professionals to generate alpha by finding and investing in these mispriced assets.

Investors should be aware that there is a wide dispersion of returns in private markets. In other words, some fund managers will generate significant alpha while others will underperform in the market. This is why selecting fund managers carefully and diversifying your portfolio across multiple managers is important.

One way to measure a manager's skill is to look at their "track record." This can be done by calculating the alpha they've generated over a certain period. However, it's important to note that past performance is no guarantee of future results. A more comprehensive assessment should also consider the manager's investment process, team, resources, and organizational structure.

In summary, private market inefficiency creates opportunities for skilled investors to generate alpha. But those opportunities only exist if the right managers are selected. Diversification is also critical to mitigating the risk of underperforming the market.

Gridline makes it easy for individuals to find and invest in top-quartile fund managers. Our platform provides access to a curated selection of professionally managed alternative investment funds. It enables investors to diversify exposure to non-public assets with lower capital minimums, fees, and greater liquidity.

Download this article for later.
Sed ut perspiciatis unde omnis iste natus error sit voluptatem accusantium doloremque.
Share this Article
Terms of Service | Privacy Policy | GLBA Notice


Disclaimer
This site is operated by Gridline Holdings, LLC ("Gridline"). Gridline does not give investment advice, endorsement, analysis or recommendations with respect to any securities. All securities listed here are being offered by, and all information included on this site is the responsibility of, the applicable issuer of such securities. Gridline has not taken any steps to verify the adequacy, accuracy or completeness of any information. Neither Gridline nor any of its officers, directors, agents and employees makes any warranty, express or implied, of any kind whatsoever related to the adequacy, accuracy or completeness of any information on this site or the use of information on this site. By accessing this site and any pages thereof, you agree to be bound by the Terms of Service and Privacy Policy

Past performance is not indicative of future results. All securities involve risk and may result in significant losses. Investing in alternative investment funds is inherently risky and illiquid, involves a high degree of risk, and is suitable only for sophisticated and qualified investors. Investors must be able to afford the loss of their entire investment. Alternative investment funds should only be part of an investor’s overall investment portfolio. Further, the alternative investment fund portion of an investor’s portfolio should include a balanced portfolio of different alternative investments. Investments in alternative investment funds are speculative and involve a high degree of risk and those investors who cannot afford to lose their entire investment should not invest. Additionally, investors may receive illiquid and/or restricted securities that may be subject to holding period requirements and/or limited liquidity. Investments in Alternative investment funds are generally highly illiquid and those investors who cannot hold an investment for the long term should not invest.

Any specific alternative investments funds referenced on this site are included purely for illustrative purposes and selected based on name recognition. Such examples are only partial, and readers should not assume that the investments identified were or will be profitable or are representative of investments by the alternative investment funds identified on this site. There is no guarantee that any alternative investment fund will achieve the same exposure to, or quality of, investments held by any existing fund referenced on this site.

Nothing on this page shall constitute an offer to sell or a solicitation of an offer to buy an interest in any investment partnership or other security. Any offer to sell or solicitation of an offer to buy an interest in an investment partnership may be made only by way of the partnership's final definitive confidential disclosure document and other offering and governance documents of any given fund (collectively, “Offering Documents”). The information on this site is qualified in its entirety and limited by reference to such Offering Documents, and in the event of any inconsistency between this site and such Offering Documents, the Offering Documents shall control. In making an investment decision, investors must rely on their own examination of the offering and the terms of any offering. Investors should not construe the contents of this site as legal, tax, investment or other advice, or a recommendation to purchase or sell any particular security.

The information included in this site is based upon information reasonably available to Gridline. Furthermore, the information included in this site has been obtained from sources Gridline believes to be reliable; however, these sources cannot be guaranteed as to their accuracy or completeness. No representation, warranty or undertaking, express or implied, is given as to the accuracy or completeness of the information contained herein, and no liability is accepted for the accuracy or completeness of any such information. This site may contain certain “forward-looking statements,” which may be identified by the use of such words as “believe,” “expect,” “anticipate,” “should,” “planned,” “estimated,” “potential,” “outlook,” “forecast,” “plan” and other similar terms. All such forward-looking statements are conditional and are subject to various factors, including, without limitation, general and local economic conditions, changing levels of competition within certain industries and markets, changes in legislation or regulation, and other economic, competitive, governmental, regulatory and technological factors, any or all of which could cause actual results to differ materially from projected results.

© 2022 Gridline Holdings, LLC