1. Introduction

A major trend among institutional investors over the past few decades is the initiation of or significant increase in private market asset allocations to complement existing public market portfolios of listed equities, fixed-income securities, and cash. According to Preqin, an alternative data provider, private market assets under management (AUM) among global investors rose from under USD1 trillion in 2000 to nearly USD12 trillion in 2022. Historically dominated by the largest institutional investors (such as sovereign wealth funds and endowments), private market investments consisting of large direct purchases of entire companies or real estate properties have evolved over the past few decades to include professionally managed private investment portfolios. For example, private market funds in the form of closed-end limited partnerships have greatly expanded private market access among small institutional investors and high-net-worth individuals.

To better prepare candidates to identify, target, evaluate, and manage private market investments throughout their financial industry careers, CFA Institute has introduced a series of Level III Private Markets Pathway learning modules, the first of which focuses on private market investments and structures.

While public markets usually involve more standardized, liquid securities of mature issuers with price transparency, private investments are characterized by unique, illiquid investments across a broader range of company life cycle stages or project development phases held for longer periods. The distinct features of private markets also lead to different investment methods and structures, which vary based on investment size, asset type, and the internal resources an investor is willing and able to commit to managing the private asset over the investment holding period. Given a greater focus on asset price appreciation over an investment life cycle among private market investments, private market performance is measured using compounded return over a multiyear period, as opposed to periodic measures more common among public market securities. These distinct features of private market investments contribute to their complementary role when combined with more traditional public equity and fixed-income securities in a strategic asset allocation.

Learning Module Overview

• Public investments typically include non-controlling positions in debt or equity claims of mature issuers. Private investments, in contrast, often include controlling or large minority stakes in firms across the entire company life cycle, as well as private real estate or infrastructure. Public markets are characterized by the ability to readily buy or sell positions, while private markets are illiquid and trade on a negotiated basis.

• Private investment methods include a direct approach for the largest investors with sufficient expertise to manage positions over an investment period and indirect approaches, such as a closed-end limited partnership. Unlike security-based public investments, private investment structures are often created and tailored to a specific use, such as an acquisition company used for buyout equity or a special purpose entity formed to manage a project among investors and stakeholders in private real estate or infrastructure.

• While public markets typically use periodic income and asset appreciation performance measures based on observed prices, the relative illiquidity, uneven cash flows, and longer investment periods for private markets lead to the use of compounded return measures to gauge returns. For example, return multiples are often used to measure the proportion of realized and unrealized returns to a private fund investor relative to funds invested.

• The greater potential return and portfolio diversification often attributed to private market investments stems from both a longer, less liquid investment life cycle with greater uncertainty and a broader investment opportunity set across both the company life cycle and various asset types.

2. Features of Private and Public Investments and Markets

Learning Outcome

The candidate should be able to:

• ☐ contrast the features of private and public investments, and discuss characteristics of private and public markets

Public investments generally involve listed securities representing debt or equity claims that are regularly traded on an exchange or among dealers in an over-the-counter market. Public fund managers invest in non-controlling debt and equity positions of more mature issuers typically with stable cash flows. Public investments are characterized by an investor’s ability to readily buy or sell positions and to observe current and historical prices for securities and relevant benchmarks, such as indexes.

Private investments are unlisted assets for which no organized exchange or over-the-counter market exists or involve companies that choose not to or cannot access public markets due to their size, stage of development, limited financial disclosure, or concentrated ownership. Private funds often acquire controlling or significant minority stakes held for longer periods over which value creation occurs, resulting in cash flow improvements, which are a primary driver of investor returns. Private debt and private equity claims are usually non-standardized contracts that are negotiated rather than exchanged on a regular basis. While private activities span a wide range of investments, including sole proprietorships, our focus here is limited to private investments of relevance to institutional investors. It is also important to distinguish between alternative investments and private investments, terms that are often used interchangeably. Alternative investments are those other than ownership of traditional public equity, public fixed-income, and cash instruments. While alternatives include most private markets, some alternative investments, such as exchange-traded commodities and hedge funds, use strategies involving public securities, which were addressed in detail in the Level II curriculum.

Some alternative investments are held in both public and private forms. For example, real estate investment trusts (REITs) hold income-producing properties and most often have publicly traded shares, while private real estate includes major refurbishment and development of commercial and residential properties, as well as timberland and farmland, which are covered in detail in a later learning module. In addition, some private companies issue public debt securities, such as high-yield bonds. The Private Markets Pathway covered in the following learning modules focuses on the following asset types:

• Private equity

• Private debt

• Private special situations

• Private real estate

• Private infrastructure

Key features that distinguish public and private investments are summarized in Exhibit 1 and are subsequently outlined in detail.

2.1. Asset Prices and Performance Measurement

Immediate access to current and historical price data for individual securities and relevant benchmarks supports a variety of public market investment approaches. For example, investors can easily measure returns, volatility, and correlations across time and construct portfolios with an efficient risk–return trade-off. Public market data are a critical input in judgement-based investment approaches seeking to capitalize on a market view, rule-based strategies using factor analysis, and index-based investment strategies.

Private market investors, in contrast, have little or no price transparency for prospective, existing, or comparable investments. As a result, investors rely on relative valuation techniques, discounted cash flow methods, and recent transactions among other approaches to estimate prices. Fund managers provide valuation estimates to investors with delays and at less frequent, often quarterly, time intervals, limiting the usefulness of such data for asset allocation purposes.

Periodic public market performance measures generally assume an initial cash outflow upon asset purchase and periodic inflows, including bond coupons, stock dividends, and net operating income for real estate. In contrast, private market investments involve far less predictable cash flows, with multiple cash outflows and inflows of ...