Private markets have traditionally been the playground of sophisticated investors in India, offering access to a vast universe of investment opportunities beyond the publicly traded landscape. Private markets have long provided useful capital both equity and debt, flexible capital structures, and strategic partners to the entrepreneurs. Over the years, this alternative investment class has gained significant traction, with an increasing number of investors and entrepreneurs both valuing its potential. However, while the allure of private markets is undeniable, navigating this space comes with its own set of opportunities and challenges.

This article delves into the pros and cons of investing in private markets, providing insights into why this sector is gaining momentum and what investors should be mindful of before stepping in. Private markets provide investors with a unique opportunity to access innovative businesses that are pioneers in their industries and are not accessible through public markets. These companies, often not yet listed on public exchanges, are at the forefront of innovation, offering groundbreaking products and services that address unmet needs. The Indian private equity sector, in particular, has witnessed remarkable growth, with assets under management exceeding ₹2.5 lakh crore as of 2022, according to the Indian Private Equity and Venture Capital Association. This growth underscores the increasing attractiveness of private markets as a means of accessing high-potential businesses that are driving innovation and transformation across various industries.

This provides investors with a lucrative opportunity to diversify their portfolios and tap into high-growth potential. The private equity asset managers in India have consistently outperformed public market indices, delivering impressive long run median annual returns of ~18% compared to the ~12% returns of the Nifty 50. This outperformance is largely attributed to the ability of private equity fund managers to identify and invest in companies with strong growth prospects, and to work closely with these companies to drive value creation.

Private markets have emerged as a vibrant ecosystem for new-age, technology-driven businesses that are revolutionizing industries and solving complex, real-world problems. These innovative enterprises are leveraging cutting-edge technologies like artificial intelligence, blockchain, robotics and the Internet of Things (IoT) to create sustainable solutions and drive transformative growth.

In addition to supporting innovative businesses, private markets are also witnessing a significant shift towards impact-driven investing. Investors are increasingly seeking opportunities that not only generate financial returns but also create positive social and environmental outcomes. This growing emphasis on impact investing is reflected in the rapid growth of India’s impact investing market, which has surged to over ₹10,000 crore in assets under management. This trend is driven by the increasing recognition that financial returns and social impact are not mutually exclusive, but rather complementary goals. By investing in impact-focused companies, investors can contribute to sustainable development, address pressing social and environmental challenges, and create long-term value for all stakeholders.

The opportunities in private markets does not come without its share of challenges. Investing in private markets can be a costly endeavour, with higher fees and commissions compared to traditional public market investments such as mutual funds and ETFs. The private equity fees in India typically range from 1% to 2% of assets under management and performance-based commissions can add another 1%-5% to the overall cost. These fees can significantly erode net returns. For instance, if an investor puts ₹1 crore into a private equity fund with a 2% management fee and a 2% performance fee, the total fees paid would be ₹200,000 (2% of ₹1 crore) plus 2% of any returns generated above a predefined benchmark. While these fees may be justified by the potential for higher returns, investors must carefully consider the costs and ensure they align with their investment goals and risk tolerance.Valuing private businesses is a complex and challenging task. Unlike public companies, private enterprises tend to be more opaque, disclosing financial information less readily. This lack of transparency makes it difficult for investors to accurately assess a company’s worth.A study by KPMG says 70% of private equity investors in India cite valuation risk as a major concern. The consequences of this opacity can be severe, leading investors to overpay for assets or misjudge a company’s growth potential. As a result, investors must employ alternative valuation methods and exercise caution when assessing private businesses. The illiquidity of private markets poses a significant challenge for investors, as it limits their ability to exit investments quickly. Unlike public markets, private markets lack organized exit avenues, such as stock exchanges, making it difficult for investors to liquidate their holdings. As a result, investors may be forced to hold onto their investments for an extended period.

The average holding period for private equity investments in India is a substantial 6-7 years with possible extensions of another 2-4 years. This is significantly longer than the holding periods typically seen in public markets, where investors can easily buy and sell securities. The extended holding period in private markets can increase the risk of investment and reduce liquidity. The absence of well-defined exit mechanisms in private markets creates uncertainty, which can lead to financial situation not favourable for investors.

Investors must therefore approach private market investments with a clear understanding of the potential exit routes, including trade sales, initial public offerings (IPOs), and secondary buyouts. By doing so, they can better navigate the complexities of private market investing and maximize their returns. Despite these challenges, private markets are becoming an integral part of investment portfolios, particularly for UHNI and family offices with large and mature public market exposures. These investors are increasingly turning to private markets to diversify their portfolios and capture the higher growth potential offered by private enterprises.

Private markets also appeal to investors looking for long-term growth and exposure to industries undergoing significant transformation, such as renewable energy, healthcare innovation, and digital infrastructure. The ability to invest in impact-focused ventures aligns with the growing emphasis on sustainability and social responsibility in investment strategies.

India’s private markets are evolving rapidly, with projections indicating continued growth over the next decade. The increasing participation of institutional investors, coupled with supportive regulatory measures, is expected to drive this expansion. For investors willing to navigate the challenges, private markets represent a compelling opportunity to participate in the success stories of tomorrow. By leveraging the expertise of experienced advisors and conducting thorough due diligence, investors can unlock the immense potential of this dynamic asset class.

In conclusion, investing in private markets offers a unique blend of opportunities and risks. While it provides access to innovative businesses and the potential for higher returns, investors must also contend with higher fees, valuation difficulties, and limited liquidity. As private markets continue to mature, they will play an increasingly significant role in shaping the investment landscape in India.

(The article is attributed to Tushar Sharma, Director- Multi-Family Office, Dewan P.N. Chopra & Co.)