Treating Your Investments Like Private Equity

Private equity consists of investments in private (non-traded) companies. They are often available through limited partnerships to institutions and high net worth investors. The partnerships require large buy-ins and have significant restrictions. These constraints create a challenge for average investors to participate in private equity investments. But that doesn’t mean we can’t incorporate some of their characteristics to increase our investment returns.

Most investors value both liquidity and real-time information. Both of these are lacking in private equity investments. However, investors can utilize these strategies in their public investments to enhance overall investment return.

Create a Liquidity Constraint

Investments in public companies are mostly liquid. We can buy and sell them at any time. While on the surface, this can be viewed as a positive, the reality is that liquidity may actually cause worse performance. Behavioral economists believe that having some sort of commitment period or locking into an investment for a period of time could be beneficial for our long-term performance. I see two reasons why this may be the case:

1) If we know we can sell an investment at any time, we may not thoroughly consider our buy decision. Most investors buy because they expect some security to go higher; there is seldom conviction behind any purchase. If we were to instill a minimum hold time for each security purchased, we would likely put a lot more thought into why we are buying something to begin with. That exercise alone could help us make better investment decisions.

2) If we can’t get out of an investment, it takes knee-jerk trading decisions out of our hands. It prevents us from acting on emotional impulses. And this could be very beneficial for us. Case in point. Let’s assume we were going to buy a security and wanted to treat it as private equity. We restrict ourselves from selling it for 10 years. We purchase the S&P 500 Index (SPY) on Mar 1, 2008. Because of the financial crisis, just one year later the investment would have lost 34%. Things were looking very bleak. If we could have sold, we probably would have. But our hands were tied. And thank goodness. By the time we could sell on Mar 1 2018, our return would have been 207%, and that is not even accounting for dividends. Most investors have long-term goals, the problem is that we get so focused on short-term outcomes that we don’t allow the long term to occur. Creating a self-imposed liquidity constraint may help.


Don’t Look at Prices

Because investments in private equity are private, prices aren’t readily accessible in the marketplace. So when we invest in private equity, we really don’t have any idea of the value at any given point in time. Together with the liquidity constraint, we just go about our day and hope that when the investment fund matures, it will have increased in value. There is little temptation to abandon or second guess private investments on a daily basis because prices are not known.

The stock market is a constant quotation machine. We can know how we are doing relative to yesterday and that plays with our emotions, and ultimately may influence our decisions. The bottom line is that we, as humans, are influenced by change. It is in our nature. So the best antidote to this, is to simply not look. It is your choice to turn on the financial media and look at your portfolio values. Or you can choose to “set it and forget it.” There have been ample studies showing that the best returns at brokerage firms had something in common – those investors had forgotten about the accounts. They set it and literally forgot about it.

Easier Said Than Done

There may not be an easy way to transform a public equity investments into private ones to protect yourself from yourself. But if your end goal is to make more money, it may be worth your time. I suggest partnering with someone to create and adhere to a durable process. Have some accountability. Just like going to a gym. Some people need a trainer to hold their hand when times are tough and keep them accountable. The same thing can be said in the financial industry.