Too Many Investors Confuse Public and Private Investments
Over the past few years, it has become increasingly evident that many investors misunderstand the vast differences between, and uses for, publicly traded securities and private exempt market securities. This article will address the mistakes investors make, as a result of this misunderstanding, and how you can educate yourself to never make this mistake again. You will be much farther ahead of the average investor after reading this article.
A Recent Conversation
I was speaking with an investor recently about a specific private energy investment. We discussed the pros and cons, risks, fees, term, management, exit strategy, and many other important features associated with the product. This is a gentleman who currently owns public stocks and bonds, mutual funds, and private exempt market securities. After the explanation, he responded by telling me that he “already has this covered”, and proceeded to mention a few of the major public energy companies in his portfolio. I quickly realized that he did not fully appreciate the major differences between public and private investments, as he clearly placed them in the same category. Here is your brief guide to understanding the main differences between public and private securities (available to the retail Canadian investor):
Publicly Traded Securities
- Normally issued via a document called a prospectus
- Some small companies (juniors) will trade on a specific venture exchange. Varying degrees of volume and liquidity.
- Once a company is large enough, it may trade on, for example, the TSX in Canada. These companies usually have many shares trading, are widely followed, and can be bought and sold easily.
- Many brokerage firms will have analysts who follow certain sectors of companies they specialize in. These companies produce quarterly analyst reports available for public consumption.
- These companies are scrutinized by thousands of eyes on a daily basis. In theory, all available information (such as earnings reports) can be transparent to all investors at the same time, so no single person (or computer) has an edge over other investors.
- These publicly traded securities (including bonds as well) will make up the majority of holdings in your typical mutual fund.
- There are varying levels of risk in public stocks, from speculative, high risk ventures to safer, blue chip companies.
Private Exempt Market Securities
- Normally issued via a document called an offering memorandum.
- Many of these opportunities are smaller in nature. Most common seem to be in the $5-30 Million range, although they can be smaller or larger.
- The legal structure is generally a limited partnership (LP). Investors purchase units in the LP.
- They do not trade on a secondary exchange, such as a stock exchange.
- Funds raised are used for a number of small business purposes. Many are real asset purchases, such as farmland, real estate, energy assets, or lending strategies backed up by real estate as collateral.
- Individual projects are less scrutinized by regulators than public companies.
- Independent research is available on many exempt market products, but research is generally not as comprehensive as the public markets.
- It is estimated that the size of businesses in the exempt market comprise over 98% of all businesses in Canada. This means that most businesses would qualify for the exempt markets and not public market listing.
- Every exempt market product is viewed as high risk by regulators. This is mainly due to lack of liquidity, size, regulatory scrutiny, and other risk factors.
Advantages of Public vs. Private
- Excellent gains can be made in a bull market environment, such as the past 5 years. Private securities will not directly benefit from an all-encompassing upward movement in the public markets
- Liquidity, as they can normally be traded easily and quickly. There is no secondary market for private investments.
- Ability to easily diversify into international opportunities. By contrast, most exempt market products are Canadian, some are American.
- Transparency- You can pretty much find out anything you want about most companies
- The ability to choose varying types, sizes, and risk levels. All private exempt market products are viewed by regulators to be high risk.
- You do not have to qualify to purchase public stocks. Exempt market products have provincial qualification standards.
- Ease of purchase- After you set up an account and fund it, simply click a mouse and you can trade stocks.
- Easy to purchase a well-diversified portfolio of stocks (ie mutual fund or ETF) with a very low purchase amount ie $500. Most exempt market purchases are more restrictive, and have higher minimums starting at $5000 or higher.
- Can make monthly purchases into a mutual fund. You cannot do this with exempt market products.
Advantages of Private vs. Public
- Higher yields on fixed income products of 6,8,10% and higher, to compensate for risk.
- Higher return opportunity on growth products, to compensate for risk.
- Access to investment areas not available in the public markets. For example, many investors are unaware that publicly traded companies in Canada cannot purchase farmland. It has to be accessed privately.
- The ability for management to use their specialized expertise to create high barriers to entry.
- The ability for high quality management to purchase assets at a significant discount to intrinsic value. This can lower risk tremendously, creating safety, plus additional gains that would be very difficult to attain in the public markets.
- Immunity from stock market crashes caused by, for example, the 2008 liquidity crisis.
- A properly diversified portfolio of real assets can provide protection from inflation unavailable in the stock market.
To view billionaire investor Michael Lee-Chin speak about the differences between public and private investments, click here.
What Is The Secret to Success?
You must realize that there are distinct differences between the private and public markets. They need to be considered as complementary, and not overlapping, due to their disctinctly fundamental differences. The best advice I can give is to learn how the true money management professionals, such as the highest quality pension plans and endowment funds, allocate their assets. The smartest investors in the world are always agnostic when it comes to public vs private. They realize that there are distinct benefits and disadvantages to each. A well-designed portfolio, one that accepts the lowest risk with the highest opportunity for return, is going to intelligently acquire healthy allocations of both types, in order to achieve the best chance of success. To learn more about both public and private assets, and how to:
- Lower overall portfolio risk, so you can sleep better
- Create multiple sources of income and growth, creating more opportunities to reach investment goals
- Lessen exposure to the stock market rollercoaster ride, and reduce investment stress
- Prepare your portfolio for possible upcoming inflation
- Create “peace of money mind”
simply download the “Guide to Real Assets and if They Are Right For You”, located to your right.