When an investment team brings forward a private markets opportunity, the work does not end with the diligence decision. From an operations and compliance standpoint, everything that follows has to be managed and reproducible. That includes legal documentation like LPAs, PPMs, and subscription agreements. It includes oversight on treasury management, capital calls, what is funded and what is unfunded. It includes statements, reporting, and the full history of capital events tied to the investment.
“All of that has to be reproducible,” Co-founder & CEO of Gridline, Logan Henderson, explains. “When you go through an SEC exam, a key focus point is alternatives. You have to be able to produce every statement related to the investment. All the legal documents. All the capital events that have happened.”
The challenge is not that firms lack this information. The challenge is that it tends to live in many places at once.
Most RIAs manage diligence and documentation across shared drives like Google Drive, SharePoint, or OneDrive. Fund administrators have their own portals. Reporting lives somewhere else. The only way to stitch it together into something resembling an audit trail is often a spreadsheet. According to a 2023 industry survey, only 10% of RIAs say their firm has the technology needed to compete effectively, and portfolio management and data integration are cited as among the biggest tech pain points at firms today.
“If I try to look up a fund,” Logan says, “I get a thousand documents. Unless I remember the exact naming convention, I can’t find what I’m looking for.”
Over time, that fragmentation creates pressure on the back office. In many firms, one person becomes responsible for pulling documents, tracking capital calls, reconciling statements, and responding to requests.
“There’s typically one person who owns all of that,” Logan notes. “At quarter end, you lose them for a week just pulling papers. If they’re out and a capital call comes in with a seven-day turnaround, you have a problem.”
This is where “no” becomes the safest answer. “Most back offices end up saying no because the work product just grows,” Logan says. “Every new investment adds more coordination, more paperwork, more risk.” In that context, saying no is not resistance. It is risk management.
High-functioning operations teams do not eliminate risk. They make risk visible, manageable, and repeatable.
When Ops and Compliance are supported by centralized data and clear infrastructure, the role of the function begins to shift. The work doesn’t disappear, but the friction around it does. A few things start to change across the firm.
More opportunities can be reviewed without compressing standards. Diligence does not restart from scratch each time, because documentation, prior analysis, and historical context are already accessible. Teams can look at a broader universe without adding a proportional burden.
Advisors are not recreating explanations or hunting for materials before every client conversation. The rationale behind an investment is easier to access, more consistent, and easier to stand behind, which changes how confidently recommendations are delivered.
Instead of reacting during exams or reviews, firms can clearly show how decisions were made, what risks were considered, and how suitability and education were handled. The work is already there. It just needs to be surfaced.
New investments no longer automatically imply new headcount, new bottlenecks, or new single points of failure. Complexity still exists, but it’s absorbed by systems rather than people.
As Logan puts it, “If Ops can maintain oversight and centralization, they can actually enable the investment team to move faster.”
Ops can say yes when the firm has infrastructure that does three things reliably. It captures the right data, it structures it the same way every time, and it makes it retrievable in seconds.
That requires more than storage. It requires a system that is built to treat private investments as structured records, not folders.
Not a drive. Not a portal. A single investment record that holds the full chain of artifacts in one place:
This matters because reproducibility is not a filing problem. It’s a linkage problem. The record only holds up if every document and event is tied back to the same investment and the same clients.
Private investments do not report consistently. A venture fund statement and a private credit fund statement look nothing alike. The correct infrastructure converts those inputs into standardized fields:
This is what makes portfolio oversight and reporting possible without manual reconciliation. It is also what enables treasury oversight. When structured data is loaded into standardized fields, funded and unfunded are no longer a spreadsheet estimate. Instead, they’re live numbers that can be readily reported on and pushed to the teammates that need them within your organization.
Ops risks often show up in capital events. Navigating the sensitivity of the situation is something you may not expect from your infrastructure. To ease the burden on your front line, a platform has to treat these delicate situations proactively as part of the data architecture. Said more pointedly: treated as first-class objects, not emails.
This is where Ops gets leverage. The system carries the state of work, so coordination doesn’t rely on individual memory.
The point is not that the data exists. Rather, it is that it can be produced quickly in a way that is complete and defensible:
This is the difference between “we have the files” and “we can reproduce the process.”
AI becomes useful when it is grounded in the actual record, rather than operating on isolated documents or one-off workflows:
When Operations can say yes, it’s not because risk has disappeared. It’s because risk is visible, structured, and owned by the system rather than absorbed by individuals.
That shift changes how the firm moves. Not overnight, and not all at once, but steadily. Decisions carry forward with less resistance. Conversations generate consensus. Reviews become productive and less fragile. Growth feels intentional rather than reactive.
In private markets, opportunity is plentiful. Complexity is constant. What differentiates firms over time is whether they build the infrastructure to carry that complexity while elevating the key resources responsible for driving the success of the project.
When ops has the tools to maintain oversight and continuity, saying yes stops being a risk. It becomes a capability.
Gridline is an end-to-end alternatives management platform built to support how RIAs actually operate private markets at scale. We centralize the full alternatives workflow, from diligence and fund launch through portfolio oversight, reporting, and ongoing operations, so private investments can be managed with the same clarity and control as public markets.
At the core of the platform is purpose-built infrastructure designed for private assets, paired with AI that strengthens decision-making, preserves institutional knowledge, and creates a durable audit trail over time.
AltComply is Gridline’s AI-powered diligence capability. It helps firms structure, retain, and reuse investment analysis so judgment compounds across opportunities, teams, and time, supporting investment committees, advisors, and compliance from a single source of truth. AltComply streamlines private fund diligence by transforming raw documents into structured, AI-generated insights, investment committee memos, and DDQs, creating a repeatable, auditable process teams can trust. It also includes an AI-powered red flag engine that surfaces non-standard terms and areas requiring closer review within private fund documents, along with an interactive Q&A that allows teams to ask natural-language questions and receive clear, cited answers grounded in the source materials.
The result? RIAs that are empowered to move faster and make better-informed decisions. That’s what it means to set a new standard in alternative investing.
The allure of private equity lies in its potential for superior returns, which hasn’t escaped individual investors’ notice. Over the past quarter-century, private equity has yielded an impressive 14% return globally, doubling the 7% offered by the MSCI World Index.
Nevertheless, in contrast to public markets, success in private markets is far from a given, owing to the challenge of picking the right investments and the relative scarcity of data.
Mechanism design is employed to safeguard returns on private investments, including but not limited to governance, project finance, return protection, and meticulous control mechanisms.
Mechanism design, often hailed as ‘reverse game theory,’ has its roots firmly planted in the arena of economic theory. Championed by Leonid Hurwicz, the 2007 Nobel Laureate in Economics, it revolves around creating a strategic environment or ‘game’ that induces participants to behave in a way that leads to a desired outcome.
Hurwicz and his collaborators, Eric Maskin and Roger Myerson, also Nobel Laureates, made significant contributions to developing and applying this theory. Their work has provided a theoretical basis for understanding how private markets function.
As per Hurwicz’s theory, mechanism design attempts to construct systems that provide the right incentives to encourage the most beneficial behavior from each participant. It’s like designing a game where the rules are laid out so that the players, acting in their own self-interest, will bring about an optimal outcome for everyone involved.
In private markets, the mechanism design theory finds significant application. Consider private equity, for example, where the relationship between general partners (GPs) and limited partners (LPs) is a prime case of a ‘game.’ The GPs, who manage the investments, and the LPs, who provide the capital, have incentives and information. The mechanisms used, such as carried interest and hurdle rates, align the interests of the GPs and LPs, leading to mutually beneficial outcomes.
Fortunately, private market conventions have evolved to align interests. For example, fees over the first several years of an investment partnership are commonly calculated on committed capital rather than invested capital, reducing the incentive for GPs to quickly invest in substandard deals to start receiving fee income. Similarly, carried interest (commonly called carry) often represents 20% of the proceeds from any investment sale, but that is frequently only available to GPs if the investment being sold has compounded in value above 8% annually. This ensures that GPs are not being rewarded for holding a mediocre investment for several years, nor are they receiving carry based on their own estimates of portfolio value.
A deep dive into the performance of private markets over the past two decades unveils a consistent trend of outperformance compared to their public counterparts. The Hamilton Lane 2022 market overview report provides compelling evidence of this. It reveals that every year in the past twenty, buyout returns in private markets have surpassed the MSCI World PME by a staggering average of 1,000 basis points.
Similarly, private credit has not lagged, having consistently exceeded the performance of leveraged loans annually by an impressive 625 basis points over the same period. This long-standing trend demonstrates the potential for superior returns in the private market sector.
During 2022, private markets displayed remarkable resilience, surpassing public strategies across all sectors. Illustratively, buyout returns in private markets outpaced the S&P 500 by almost 2,050 basis points. Furthermore, the private sector’s infrastructure and real estate exceeded the FTSE All Equity REITs Index by a considerable margin, over 3,400 basis points, to be precise.
A 2023 survey showed that 86% of participants believe that the trend of private markets outperforming public markets is likely to continue. This sentiment points to the growing confidence in private markets and their potential for higher returns.
Moreover, historical data indicates that private equity provides superior risk-adjusted returns and tends to outperform public equity by a more significant margin, especially during periods of economic distress. This pattern suggests that the mechanisms at play within private markets can effectively contribute to higher returns.
With Gridline, private market investing becomes more straightforward and more accessible. We provide the tools to navigate these markets effectively, harnessing the power of diversified, professionally managed funds.
The classic investment disclaimer, “past results are not an indicator of future success,” is never more important than when considering established fund managers against emerging fund managers.
Venture capital is a space where strong early returns can reverse in a hurry. Nearly 18% of first-time funds nab an internal rate of return (IRR) of at least 25%, while later funds only exceed that number about 12% of the time, according to Pitchbook research.
Newer managers – defined here as having three or fewer funds under their belt- have some inherent advantages. They frequently have spun out of larger funds, bringing years of experience honing their craft at large firms. Additionally, these newer managers can bring innovative new ideas to the table by striking out on their own, helping recognize trends that more established funds may miss.
Here are four more reasons why emerging managers tend to hit home runs:
The IRR of early funds is a crucial indicator for emerging managers. High early IRRs help managers recruit new LPs, increase check sizes from follow-on LPs for future funds, and build out young organizations.
Emerging managers often leave secure, high-paying jobs to start their own funds, facing significant uncertainty. This only makes sense if those managers truly believe in the potential to generate outsized returns in their area of focus. Because these managers have an outsized personal and professional stake in Fund I’s success, those funds are more likely to outperform.
The math is more favorable for smaller funds. A smaller fund means smaller checks, which naturally makes generating higher returns a little easier. You’re more likely to exit at $100 million than something like $1 billion. When you scale up a fund size, you either have to invest in more companies or make bigger investments. The former stretches your human capital, and the latter could put you in a much different market from where you’ve found prior success.
We’re strong believers in actively managed funds, where fund managers don’t just give startups cash but they offer expertise through board seats or technical assistance to ensure venture-backed companies thrive. Gridline has a cohort of top-notch, experienced investors, and we’ve benefited from their active involvement, industry expertise, and network.
That model doesn’t scale well when human capital is limited. Diminishing returns can be a real problem in labor-intensive tasks like building companies. Limited attention is one of the big drivers of the wide dispersion in returns you see across private equity, with investments underperforming substantially when firms have a large number of simultaneous investments.
Asset management consultant MJ Hudson noted in a 2018 report that while management fees for larger funds are falling, the size of funds has increased so substantially that these fees represent a “significant profit center.”
That can create misalignment between fund managers and their investors. Established managers raising mega-funds, who may have fees coming in from prior funds as well, may not feel the same pressure to hit a home run and cash in on their performance fee. They can return nothing to investors and still earn plenty, thanks to the size of the fund.
Emerging managers not only have a smaller share of their income coming from management fees, but they’re also trying to build a personal brand to justify bigger, successive funds. You can only do that with a strong performance.
Emerging managers are grinders, hungry for success the way a young underdog is against a perennial winner in the sports world. This tightly aligns their goals with LPs – a strong return means both the manager and their partners win.
Information asymmetry, the phenomenon where one party has more or better information than another, has long been a subject of interest for economists and market participants.
Recognized by George Akerlof, Michael Spence, and Joseph Stiglitz with a Nobel Prize in 2001, information asymmetry has significant implications in the world of investing. In private markets, this disparity in information can lead to lucrative investment opportunities for savvy investors who can effectively identify and capitalize on these inefficiencies.
Let’s see how investors can leverage information asymmetry in private markets to gain a competitive advantage and ultimately achieve superior returns.
Unlike public markets, where companies must disclose financial information and comply with strict regulatory requirements, private markets are characterized by a relative lack of transparency.
Nonetheless, private capital AUM grew from $4.08tn at the end of 2015 to $8.90tn at the end of 2021, representing a compound annual growth rate of 13.9%. Further, Preqin predicts that global AUM for the alternative asset class will increase to $23.21tn by 2026. This growth can be attributed, in part, to the potential for higher returns and diversification benefits offered by private markets.
Information asymmetry in private markets can arise from various factors. One key contributor is the limited financial disclosure of private companies. A report by Preqin revealed that 59% of private equity investors cited a need for improved fund transparency to improve the alignment of interests.
Unlike their public counterparts, private firms are not mandated to release detailed financial information, making it challenging for investors to assess their true value. Further, investors with specialized knowledge and industry experience may possess information not readily available to others, enabling them to make better-informed decisions. Lastly, investors who have built strong networks and relationships within a particular industry can gain valuable insights and access to opportunities others may not be privy to.
While information asymmetry in private markets presents opportunities for investors to achieve superior returns, it also poses unique challenges. The lack of transparency and limited financial disclosure can make it difficult for investors to accurately assess the value of potential investments, leading to a higher risk of loss or underperformance if the hidden risks are not appropriately accounted for.
This underscores the importance of a rigorous approach to investment selection, due diligence, and risk assessment.
Leveraging information asymmetry in private markets offers numerous benefits. One of the most significant advantages is the potential for superior returns. Investors can achieve higher returns than those attainable in more efficient public markets by capitalizing on market inefficiencies.
According to a study by Cambridge Associates, investments led by section specialists across four sectors generated a 23.2% gross IRR, outperforming generalist investments at 17.5%. A rigorous approach to investment selection is needed to uncover these opportunities.
A data-driven approach also helps investors to uncover mispriced assets. A report by Broadridge found that 60% of asset managers believe that leveraging data and analytics is essential to gaining a competitive advantage in the market.
Moreover, a deeper understanding of a company or industry can help investors more accurately assess risk and make better-informed investment decisions. This knowledge-driven approach can ultimately lead to enhanced portfolio performance and risk mitigation.
Gridline, an alternative investment platform, effectively navigates the challenges of information asymmetry in private markets by providing rigorous analysis, expertise, and access for investors. By leveraging its deep industry knowledge, proprietary data, analytics, and strong networks and relationships, Gridline uncovers hidden opportunities, mitigates risks, and ultimately helps investors achieve superior returns.
The first quarter of 2023 was marked by significant challenges in the banking industry, with the collapse of major players such as Silvergate, Signature, and Silicon Valley Bank, followed by the rescue of Credit Suisse. The collapse of Signature and SVB alone marked the second and third-largest bank failures in American history.
Despite this crisis, PE showed remarkable resilience. Let’s examine the factors contributing to PE’s stability and explore how the industry maintained its momentum in Q1.
Research from PitchBook shows that, amidst the banking crisis, private equity firms announced five mega-deals worth a combined $31.3 billion. Among these was the year’s most significant, Qualtrics’ take-private deal for $12.5 billion. While banks, venture capital, and public markets faced turbulence, the PE industry was practically unbothered, adapting to the altered financial landscape.
The ability of private equity firms to push through mega-deals can be attributed to several factors. These include their existing relationships with limited partners, access to alternative funding sources, and a strong track record of delivering returns in past financial crises.
Although there were changes in how PE deals were structured, the industry remained resilient. For instance, large LBOs in the tech sector required 70% to 92% in equity in March, compared to a historical average of 48%. This shift reflects the scarcity of debt capital available for funding mega-deals, which was a consequence of the banking turmoil.
To adapt to the scarcity of debt capital, private equity firms have had to rely more on equity financing, tapping into their extensive network of limited partners to raise capital. This has allowed them to continue investing and generating returns, despite the challenging market conditions.
Some PE firms have turned to alternative sources of financing, such as private credit funds, which have become more attractive as the traditional banking sector has struggled. This has allowed private equity firms to access funding without relying on banks.
The decline in purchase price multiples also enabled recent vintage funds to buy at compelling prices, augmenting returns and compensating for the lack of debt leverage.
PE deployment demonstrated signs of stabilization in Q1, following a 38% peak-to-trough decline in quarterly value. Fundraising fell less than some predicted, with $66.8 billion in funds closed. Furthermore, performance steadied after negative returns, as indicative returns from public PE managers pointed to modest appreciation in the final quarter of 2022.
Private equity firms could maintain fundraising momentum due to their strong track record, reputation for stability, and the confidence of limited partners. The success of PE fundraising can also be attributed to the diversification of their portfolios, focusing on sectors that have proven to be resilient during the crisis, such as healthcare, technology, and renewable energy. In fact, healthcare private equity had its second-best year in 2022, in terms of volume and value.
This diversification has given investors confidence in private equity firms’ ability to navigate the current financial landscape. At the same time, global pension funds increasingly look to private assets to build resilience.
The challenges faced by the banking industry in Q1 2023 have provided valuable lessons for the private equity sector. As a result, PE firms have become more vigilant in their risk management, focusing on portfolio diversification and enhancing due diligence processes. This proactive approach has contributed to the industry’s resilience during turbulent times.
The reliance on alternative funding sources, such as private credit funds, has expanded the financing options available to private equity firms. This development may shape the industry’s future, as it reduces dependence on traditional banks and opens up new opportunities for growth and deal-making. With a record $3.7 trillion in dry powder, the private equity sector is well-positioned to continue its growth trajectory.
In the public equity markets, top-performing and bottom-performing managers provide returns within a relatively tight band. For example, the 5th percentile of managers returns around 5%, and the 95th percentile is around 10%. Further, persistence is almost non-existent: the top-performing managers in one year are unlikely to repeat their performance in subsequent years, and neither are the bottom performers.
In contrast, the dispersion of returns is much wider in the venture capital (VC) industry. The 5th percentile of managers lose money, and the 95th percentile returns over 40%. Further, persistence is strong: the top-performing VCs in one year are likelier to repeat their performance in subsequent years than the bottom performers.
One study finds a correlation of nearly 0.7 between a VC’s return in one year and its return in the next year. This research isn’t alone; Morgan Stanley points to “other researchers, using different data and methods, [who] find continued evidence of persistence.”
This means that the best VCs are much more likely than the average public equity manager to generate significant outperformance. Fund selection is critical in VC and worth paying attention to a VCs track record. That said, there are many other factors at play in VC—the stage of the company, the industry, the quality of the management team, and so on—so fund selection is only a part of what goes into a successful investment.
There are a few possible explanations. For one, VCs invest in entrepreneurs, and entrepreneurs with a track record of success are more likely to be successful again. In fact, Harvard research shows that a successful VC-backed entrepreneur has a 30% chance of succeeding in his next venture, while first-time entrepreneurs have only a 21% chance. Accessing these serial entrepreneurs is a key to successful VC investing, and the best VCs have a network of them.
Another explanation is that early VC success “leads to investing in later rounds and larger syndicates,” which means that top-quartile VCs have greater access to deal flow. This preferential access gives them an informational edge, leading to better returns. Access-constrained funds, or those with greater access to privileged opportunities, outperform across the board.
Further, a recent Oxford Journal paper theorizes that “successful funds receive continuation contracts that tolerate investment failure and encourage innovation.” In other words, the best VCs are given more leeway to take risks, which leads to more success.
The simplest explanation is that top-quartile VCs are better at what they do. They have a superior understanding of the startups in their portfolio and are better at working with entrepreneurs to help them grow their businesses. These advantages compound over time, leading to better and better performance.
This isn’t to say that all VCs are created equal; the best have a rare combination of skills, experience, and networks. But if you’re looking to invest in VC, it’s important to consider persistence. The best funds have a strong track record of delivering superior returns and are more likely to do so in the future.
Gridline considers all these factors when curating a selection of professionally managed alternative investment funds for individual investors. With lower capital minimums, fees, and greater liquidity, Gridline is the most efficient way to gain diversified exposure to non-public assets.
Money creation is the king of the economy. But, just as the Federal Reserve eased monetary policy to manage the economic recovery from the pandemic, the opposite is true today; money “unprinting” is in full force.
In January, the data showed that, while the U.S. money supply quickly increased until April 2021, it had fallen negative for the first time in 28 years by the end of 2022. For the past three months, money supply growth has continued declining, and it’s now at its lowest level in 35 years.
Investors must consider how the Fed’s money un-printing policy will affect their investments in the coming year.
2021 saw the fastest bull market recovery since World War II, thanks to the Fed’s record-breaking quantitative easing (QE) and other accommodative policies. That’s because the Fed’s QE flooded the money economy with new cash and reduced the cost of borrowing.
However, money un-printing takes the opposite approach. Essentially, it’s an attempt to slow the pace of economic expansion and tame inflation. This approach, however, comes with consequences.
The collapse of Silicon Valley Bank (SVB) shows how the unprinting of money can be disastrous. SVB’s bond portfolio yielded a 1.79% rate compared to the 3.9% offered by US treasuries. After the bank decided to sell new shares to make up for its losses, its stock price plummeted by as much as 60 percent, prompting a run on the bank to the tune of $42 billion.
SVB is neither the first nor only casualty of the un-printing of money; it’s just a high-profile example. SVB has done business with nearly half of US tech startups, illustrating the ripple effect of quantitative tightening on the economy. On a macroeconomic level, the data shows that the monetary slowdown has already impacted growth: Home prices, job openings, and the manufacturing outlook are down, while credit card debt and consumer loan delinquencies are up.
The loss of “easy money” creates an environment of risk aversion. In such an environment, investors need to be even more cautious in their investments and focus on the long-term horizon. The key is to look for value beyond the short-term turbulence.
Historically, private markets have strongly outperformed in times of monetary tightening. There are several reasons for this: private markets are more insulated from public market volatility, and private market assets tend to be less liquid than their public counterparts, which makes them less affected by short-term shifts in the market.
With a longer holding period and over a trillion dollars in dry powder, VCs can ride out the storm, buying out discounted companies along the way. They can then integrate these companies into their portfolio, providing a quick shot of growth and opportunities for market consolidation. That’s why VCs are still winning and continuing to find investments.
This is not to suggest that financial professionals take a blind bet on private markets; the key is to be judicious in your investments and to consider each opportunity carefully. A good starting point is Gridline, a digital wealth platform that provides access to a curated selection of professionally managed alternative investment funds. With Gridline, you can gain diversified exposure to non-public assets with lower capital minimums, lower fees, and greater liquidity.
Private markets have long outperformed public markets. Several arguments have been put forth to explain this outperformance.
One common explanation is that private companies are less efficiently priced due to information asymmetries between insiders and the market at large. Additionally, a liquidity premium exists in private markets, as investors are unable or unwilling to exit their positions as quickly as in public markets.
Even the short-termism of public markets plays a role in the outperformance of private companies. Public companies are pressured to deliver quarterly results, while private companies can take a longer-term view. This gives private companies a significant advantage when making strategic investments, such as research and development or long-term marketing campaigns.
But a more nuanced explanation may be that active private market managers have more opportunities to generate alpha.
Active management refers to actions taken by a manager that deviate from a passive strategy, such as security selection, market timing, or dynamic asset allocation. Active private market managers may also add value through their relationships and networks.
Preferential access to investments, greater control over portfolio composition, and the ability to take a longer-term view are all factors that may allow active private market managers to generate alpha. Good fund managers diligently pick winning companies and nurture those investments to ensure they’re successful.
The “fundamental law of active management,” which says an investor’s excess return equals skill times opportunity, separates the winners from the losers.
Manager selection is comparatively more complicated in private markets due to the lack of transparency and availability of information. At the same time, it’s also far more critical in private markets due to the wider dispersion of returns. While top-quartile private equity funds produce, on average, an incredible 30% net IRR, many bottom-quartile funds lose money. The median fund’s 19% net IRR still significantly outperforms public markets, but even better returns can be achieved.
Therefore, Gridline carefully selects managers based on several quantitative and qualitative criteria that may predict outperformance. These include, but are not limited to, past performance, a conviction in the investment thesis, preferential access to investments, and the ability to add value through portfolio construction and monitoring.
To select the best managers, Gridline relies on a combination of screening tools and due diligence conducted by our team of experts. Our screening tools help to identify managers that meet our criteria, while our due diligence process allows us to assess further a manager’s skills, capabilities, and investment process.
Rather than relying solely on the built-in liquidity premium of private markets or even the “complexity premium” associated with less efficiently priced securities, Gridline looks for managers that can generate alpha through active management. We believe this is the best way to achieve superior long-term returns for our investors.
Private markets have delivered superior returns for several reasons. Inefficiencies in pricing and liquidity premiums are among the most commonly cited explanations.
However, more significant opportunities for alpha generation may be the most critical factor. Active private market managers have several advantages, including preferential access to investments, greater control over portfolio composition, and the ability to take a longer-term view.
But manager selection is more difficult in private markets due to the lack of transparency and availability of information. Therefore, it’s essential to carefully select managers based on many criteria that may predict outperformance.
The 60/40 portfolio, comprised of 60% stocks and 40% bonds, has been the bedrock of many investors’ portfolios for decades. Now, it’s on track for its worst year in history. Interest rates have risen at the fastest pace in years, failing to tamper with 40-year highs in inflation. At the same time, stocks are underperforming as companies navigate a 180-degree turn from quantitative easing to tightening.
Many investors are looking for alternatives to the traditional portfolio in this environment. One increasingly popular option is investing in pre-IPO companies. Capital physics is less favorable for an investor when a company is listed on a public exchange. It’s much harder for a multi-billion-dollar firm to provide 10x returns than for a $100 million firm.
Pre-IPO investing offers the potential to get in before a significant liquidity event, and with firms staying private longer, there’s even more runway for returns than before. But there are risks to consider before diving in.
A growing number of investors are accessing pre-IPO companies via employee equity. Companies like Equity Bee, Quid, Equity Zen, Forge Global, and others offer accredited investors the opportunity to buy shares from employees of high-growth startups.
But there’s a catch: The shares are often significantly overpriced. In many cases, investors are paying more for employee options than the companies are valuing themselves at.
As one CPA explained for NerdWallet, the investor pays an amount between what the shares are worth and what they might be worth in the future: “Let’s say they’re sitting at $10 a share, and the company expects to IPO at $100. An accredited investor might offer to pay $40 a share.” In other words, even in a bull market, this approach means you’re paying a hefty premium for investing early.
And in a bear market, as we’re currently experiencing, the risk is even higher. Median pre-IPO tech valuations, for instance, fell by 50% in the third quarter of this year. EquityBee explains on its homepage that these platforms let investors come in “at past valuations.” That means you could be massively overpaying for a company already falling in value.
Altogether, buying employee equity is one of the most overpriced, high-risk ways to invest in pre-IPO companies.
A better way to invest in pre-IPO companies is through venture capital and private equity funds. These funds are run by experienced professionals who deeply understand the startup ecosystem and can provide mentorship and support to portfolio companies.
Additionally, these funds are much more selective than retail investors in employee equity programs. They carefully consider a company’s business model, competitive landscape, and management team before investing. As a result, they’re much less likely to overpay for a company that turns out to be a dud.
What’s more, these funds avoid the premium that comes with employee equity by investing directly in a company’s funding round. That means you’re getting in on the ground floor rather than paying extra for the privilege.
Pre-IPO investing is a risky proposition. Employee equity valuations are inflated, and you’re likely to overpay for the privilege of investing early. A better alternative is to focus on active managers who can provide mentorship and support to help a portfolio of companies move through the value creation lifecycle.
Gridline allows access to these opportunities with lower capital minimums, lower fees, and greater liquidity.
Retail and institutional investors alike have long been enamored with stock picking. On the surface, the logic is simple: find public or private stocks undervalued by the market and reap the rewards when the market catches up to their actual value.
However, despite the allure of stock picking, the reality is that it is a challenging task to do well. One study found that individual investors consistently underperform market indices at an average of 1.5% per year. Further, a Berkeley study finds that “the vast majority of day traders are unprofitable.”
Warren Buffett put it nicely: “I don’t think most people are in a position to pick single stocks.”
One challenge with stock picking is that public and private stocks have different returns. That is, some stocks will outperform the market while others will underperform.
For public stocks, the return dispersion is relatively small. This means there is no significant difference between the best and worst-performing stocks. However, for private stocks, the return dispersion is much larger.
Another challenge with private stocks is accessibility. Many private stocks are not accessible to retail investors. They may be illiquid or require a minimum investment that is too high for even well-capitalized investors.
This lack of accessibility makes it difficult for stock pickers to find private stocks undervalued by the market.
Further, high-quality data is an industry of its own and is critical for stock picking. Unfortunately, there are many challenges associated with such alternative data.
One challenge is data quality. Private companies are not required to disclose their financial information the same way public companies do. This lack of transparency can make it difficult to assess the actual value of a private company.
Another challenge is data sparsity. For many industries and countries, there is a lack of comprehensive data sets on private companies. This lack of data can make it difficult to find undervalued stocks.
Even when data is available, it may not be timely. For example, a company may announce earnings after the stock market has closed for the day. When investors access this information, the stock price may have moved significantly.
In the 1970s, academic John Bogle popularized the concept of indexing. The idea is simple: instead of trying to pick stocks, investors should buy a basket of stocks that represents the market as a whole.
This approach diversifies away individual stock risk, reduces transaction costs, and gives investors access to the entire market, not just the stocks they can find and research.
Indexing is an effective investment strategy for both public and private markets. It’s difficult for managers to outperform the S&P500 consistently. And when it comes to private markets, while individual startups have a high probability of failure, a highly diversified portfolio, such as a VC fund of funds, can be relatively low risk.
In that way, diversified investing in private markets can both offer risk reduction and greater returns. For example, a study by Cambridge Associates found that top-quartile VC funds outperformed the S&P by ~2X over the last 5-, 10-, 15-, and 25-year periods. Even the median private equity fund’s return of 19% is far higher than that of public stocks.
Stock picking is a difficult task made even more difficult by the challenges associated with accessibility and data. However, indexing provides a simple and effective solution for investors who want to participate in the private markets without picking stocks.
With Gridline, you can index the private markets and gain exposure to a wide variety of assets with low capital minimums, transparent fees, and greater liquidity.