Private equity at Vanguard

What is private equity?

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You may know us as a pioneer in index fund management, but Vanguard is also one of the world's largest providers of actively managed funds. We offered active funds even before we introduced the first index mutual fund in 1976. As part of our mission to give investors the best chance for investment success, we continuously strive to improve client outcomes. In 2020, we partnered with Harbor Vest,

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a specialist in private market investing to give qualified investors access to private equity. We believe private equity offers higher potential returns than public markets and can enhance overall portfolio diversification for suitable investors. We hope the following introductory video helps you determine whether you should further explore private equity. Thank you.

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Simply stated, private equity refers to investments in companies who shares do not trade publicly. In the United States and Europe, almost all companies are privately held. While publicly traded firms raise capital from investors via the New York Stock Exchange and other markets, privately owned companies turn to private equity investors for capital. In addition to accounting for the vast majority of firms,

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private equity represents a unique and growing segment of the global equity market. Over the past decade, the amount of assets invested through private equity funds has nearly quadrupled. At the end of 2023, private equity accounted for 10% of the total investable global equity market.

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Private equity offers suitable investors the opportunity to earn higher returns than public markets may deliver over the long term, while also providing increased portfolio diversification and expanded equity market coverage. Like any investment, private equity carries risks.

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Some risks, including liquidity and valuation risks, are unique to private equity because investments are privately held and not traded on exchanges. Other risks, including market and selection risks, are shared with public equity investments. As a result, private equity may be suitable for investors with a high tolerance for the risk of active management, long investment time horizons, and high levels of personal liquidity.

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Vanguard research suggests that exposure to a top performing private equity manager can meaningfully improve the likelihood of reaching one's investment goals relative to an equity portfolio invested entirely in the public markets. Our research has also found that successfully investing in private markets requires broad diversification and consistent access to above average private equity managers.

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Diversification has proven to be a powerful investment principle in both public and private markets, helping to reduce portfolio volatility and improve long-term returns. When considering the role of private equity in a strategic asset allocation, Vanguard views the fundamentals of private equity investments to be similar to public equities, and thus a private equity allocation should represent only a portion of an investor's equity exposure.

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For example, an investor with a 70% stock, 30% bond portfolio may target a portion of their 70% equity allocation to be held in private equity investments. Vanguard views private equity as a strategic asset class that represents a distinct and growing segment of global equity markets. It may be appropriate for eligible investors to consider allocating a portion of their overall equity exposure to private equity to achieve greater diversification, and the potential for increased long-term returns.

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Due to the unique nature of private equity, regulations require thoroughly verifying the eligibility of interested investors before discussing any fund or investment specifics. US private equity funds are traditionally structured as limited partnerships,

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which are exempt from Securities and Exchange Commission registration provided the fund meet certain regulatory requirements pertaining to its investor base. Investors, known as limited partners, must meet the regulatory definitions of qualified purchaser and accredited investor, which require the distributing firm, in this case Vanguard, to thoroughly verify the requirements with interested investors before discussing any fund or investment specifics.

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At Vanguard, private equity is currently available to individual investors with $5 million or more in investable assets. Other conditions apply.  If you believe you are eligible and that private equity is a suitable investment given your unique circumstances, please speak with your Vanguard representative to learn more.

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IMPORTANT INFORMATION

All investing is subject to risk, including the possible loss of the money you invest. There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income. Diversification does not ensure a profit or protect against a loss.

Past performance is not a guarantee of future returns.

With private equity (“PE”) investments, there are five primary risk considerations: market, asset liquidity, funding liquidity, valuation, and selection. Certain risks are believed to be compensated risks in the form of higher long-term expected returns, with the possible exceptions being valuation risk and selection risk. For selection risk, excess returns would be the potential compensation, however, limited partners (“LPs”) must perform robust diligence to identify and gain access to managers with the skill to outperform. PE investments are speculative in nature and may lose value.

Market risk: Private equity, as a form of equity capital, shares similar economic exposures as public equities. As such, investments in each can be expected to earn the equity risk premium, or compensation for assuming the nondiversifiable portion of equity risk. However, unlike public equity, private equity’s sensitivity to public markets is likely greatest during the late stages of the fund’s life because the level of equity markets around the time of portfolio company exits can negatively affect PE realizations. Though PE managers have the flexibility to potentially time portfolio company exits to complete transactions in more favorable market environments, there’s still the risk of capital loss from adverse financial conditions.

Asset liquidity risk: Various attributes can influence a security’s liquidity; specifically, the ability to buy and sell a security in a timely manner and at a fair price. Transaction costs, complexity, and the number of willing buyers and sellers are only a few examples of the factors that can affect liquidity. In the case of private equity, while secondary markets for PE fund interests exist and have matured, liquidity remains extremely limited and highly correlated with business conditions. LPs hoping to dispose of their fund interests early—especially during periods of market stress—are likely to do so at a discount.

Funding liquidity risk: The uncertainty of PE fund cash flows and the contractual obligation LPs have to meet their respective capital commitments—regardless of the market environment—make funding risk (also known as commitment risk) a key risk LPs must manage appropriately. LPs must be diligent about maintaining ample liquidity in other areas of the portfolio, or external sources, to meet capital calls upon request from the General Partners (“GPs”).

Valuation risk: Relative to public equity, where company share prices are published throughout the day and are determined by market transactions, private equity NAVs are reported quarterly, or less frequently, and reflect GP and/or third-party valuation provider estimates of portfolio fair value. Though the private equity industry has improved its practices for estimating the current value of portfolio holdings, reported NAVs likely differ from what would be the current “market price,” if holdings were transacted.

Selection risk: Whether making direct investments in private companies, PE funds, or outsourcing PE fund selection and portfolio construction to a third party, investors assume selection risk. This is because private equity doesn’t have an investable index, or rather a passive implementation option for investors to select as a means to gain broad private equity exposure. While there are measures an investor can take to limit risk, such as broad diversification and robust manager diligence, this idiosyncratic risk can’t be removed entirely or separated from other systematic drivers of return. Thus, in the absence of a passive alternative and significant performance dispersion, consistent access to top managers is essential for PE program success.

Accessibility of private equity

Private equity is generally only accessible to ultra-high-net-worth investors, either through direct investment or partnership with a private equity firm, which invests in a private equity fund. Only accredited investors who meet specific qualifications outlined in federal securities laws qualify to invest in private equity funds. Certain private equity funds require investors to meet the definition of "qualified purchaser" in addition to being an accredited investor.

This communication is for informational purposes only and does not constitute an offer or solicitation to purchase any investment solutions or a recommendation to buy or sell a security, nor is it to be construed as legal, tax, or investment advice. Private investments involve a high degree of risk, and therefore, should be undertaken only by prospective investors capable of evaluating and bearing the risks such an investment represents. Investors in private equity generally must meet certain minimum financial qualifications that may make it unsuitable for specific market participants.

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