Private Markets Four Areas

Jumping between topics related to tech and markets, this week I wanted to address four compelling areas of the private markets. For each of these markets, we prefer smaller managers with long operating track records. Public markets continue to converge around the US mega cap tech theme. Diversified investors need to find compelling alternative quality opportunities and in public markets that can be a real challenge.

Conceptually, diversified portfolios should only include investments that are compelling in their own right. Niche private market strategies earn their returns based on unique activities and risk exposures, making them compelling candidates for true diversification. I won’t be referring to particular funds by name in this article, also for compliance reasons, but I’m happy to discuss details directly. I can be reached by replying to this email.

Venture Debt

The investment industry tends not to refer to this as private credit, but that’s what it is. It’s a niche area of the private credit landscape. Founders who want to raise capital for their company can sell equity or they can borrow at fairly high interest rates for short periods until they hit new milestones that bump up their valuation. Selling equity is often more expensive than paying 15% interest on a short term loan. Venture debt loans typically come with a small piece of equity called a warrant which help juice the returns for investors. Like all lending, success is dependent on conservative and disciplined underwriting. Partnering with a seasoned venture debt team is an important risk management variable. Some funds negotiate rights to invest in equity rounds, which can also be valuable in the right circumstances.

Distressed Real Estate Debt

There are daily headlines about financially disastrous real estate outcomes from office to multi-family, particularly in big cities like New York. As debt matures and cannot be profitably converted at higher interest rates, this creates potential bankruptcy scenarios and opportunities for investors who know the space well. Even if it seems like something you’d want to avoid, distressed sectors are an opportunity, by definition. If you are thinking with an index mindset, then you are right, you would never want to use an index approach in a distressed asset class. Talented managers who live in this space have a unique opportunity to invest where others can’t or won’t, either because they don’t have the experience or the vehicle to execute the investments.

Small Modern Urban Rental Real Estate

Small urban rentals are a highly fragmented market. These are rental buildings with three to fifty units. There are 15,000 small multifamily units in MA and 2m across the US. Most of these are already owned by investors, so institutional participation is not taking opportunities from families who want to own their homes. In MA only 32% of this asset class is owned by occupants who also live in the building. Of the investor-owned units, 88% are owned by small investors who tend not to invest to upgrade their buildings to modern standards over longer periods. Institutional investors have typically overlooked this space due to operational complications, but tech-savvy efficient operators have found unique ways to turn this asset class from too challenging to profitable at scale.

Real Estate Private Credit

When a small real estate investor or developer cannot get a traditional bank loan for a property, mortgage brokers will refer them to local private credit funds. The variety this referral channel implies is true, there are different real estate private credit funds for every region and every circumstance in the US. Some focus on Florida, the Sunbelt or Massachusetts only and all come with unique ways of managing risk and return. These are short-term relatively high-interest-rate loans that will be refinanced at lower rates once the project is completed.