Diversifying your portfolio is one of the foundational principles of investing. By spreading investments across different asset classes, industries, and stages, investors may be able to mitigate some of the risk that comes with investing. While diversification methods apply to both public and private markets, the approaches and considerations for both can differ. In this blog, learn more about diversifying your portfolio in the public and private markets, allocation strategies, and some key considerations for investors.

Diversifying Your Portfolio: Public and Private Markets

Before going into diversification strategies, it’s important to understand the differences between public and private markets.

Public Markets

The public markets include securities traded on regulated exchanges like the New York Stock Exchange (NYSE) and NASDAQ. Accessibly by anyone, public markets include securities like stocks, bonds, exchange-traded funds (ETFs), and mutual funds. Some characteristics of public markets include high liquidity, high transparency, strict oversight and regulation, and short-term volatility.

Private Markets

The private markets include investments that are not listed on these public exchanges and include forms of investments like private equity, venture capital, real estate, and private debt. These investments may only be available to accredited investors, or those that meet specific income, net worth, or knowledge requirements, but some forms, like Regulation Crowdfunding, are also accessible to anyone. Some characteristics of private markets include limited liquidity, limited transparency, high growth potential, and reduced market correlation.

Diversification Strategies

While the core principles of diversification apply to both public and private markets, there are some key differences for investors to consider.

Similarities

1. Spreading Risk Across Industries

Just as public market investors diversify across tech, healthcare, consumer goods, and other industries, private market investors should consider avoiding over-concentration in a single sector. For example, a private market portfolio highly concentrated in the fintech industry could struggle if regulatory changes impact the industry.

2. Balancing Company Stages

In the public markets, investors might hold a mix of large-cap (stable) and small-cap (high-growth) stocks. Similarly, private market investors can diversify between early-stage startups, those who are in their early stages but generally hold higher risk, and late-stage companies, that are typically right before an initial public offering (IPO).

3. Geographic Diversification

Global diversification can reduce exposure to regional economic downturns across the public and private markets. Public investors may buy international ETFs or invest in single stocks for international companies, while private investors may choose to back startups in emerging markets.

4. Asset Class Allocation

Across the public and private markets, investors may also choose to diversify across asset types. In the public market, this might look like diversifying across stocks, bonds, and commodities. In the private market, this might look like diversifying across private equity, private credit, real estate, infrastructure, or other asset classes.

Differences

While the goals of diversification apply across the public and private markets, the execution may vary due to the structural differences between the two markets.

1. Liquidity Constraints

The public markets are very liquid, enabling investors to quickly buy and sell stocks during downturns or upswings. Private markets, however, are inherently illiquid and often require a significantly longer holding period. Public market investors are able to rebalance their portfolio weekly, monthly, quarterly, or annually, while private market investors need to commit capital with a long-term mindset. Upfront diversification is very important when it comes to inherently illiquid investments.

2. Information Availability

Publicly held companies are required to file quarterly reports, making it easier for investors to assess performance and make portfolio decisions. On the other hand, private companies do not have these requirements, and may only provide limited data. In the public market, investors can use financial statements, analyst reports, and earnings calls to make decisions. In the private market, investors can use investor updates, cap tables, or even direct communication with founders if available to research opportunities.

3. Minimum Investment Requirements

In public markets, investors are able to buy shares in small increments, or even fractional shares. Alternatively, private markets often require larger investments, which can be upwards of $5k-$15k per startup. Private market investors may choose to diversify using venture capital funds, which pool capital from investors and make investments across multiple companies, enabling private market investments at lowered minimums.

Key Considerations

When choosing to invest in the public or private markets, there are a few key considerations that investors should keep in mind.

Public Market Considerations

The public market may be able to provide cost efficiency for investors, as ETFs and index funds can typically provide diversification at lower fees. However, there are also tax implications to take into account. Frequent trading can trigger capital gains taxes – longer terms holds may be more tax-efficient for public market investors. Investors should consult their own qualified tax advisor regarding the tax consequences of their specific situation. Additionally, public market investors should avoid emotional decisions during volatility.

Private Market Considerations

When investing in the private markets, investors should consider illiquidity, due diligence, portfolio construction, and exit opportunities. Due to the illiquid nature of the private market and long holding periods, investors should only invest capital that is not needed for years. Additionally, a higher level of due diligence may be required due to the limited information that is available. Finally, private market investors should be prepared to hold on to their investments until exit or failure, which can take years to manifest. There may be opportunities to sell your shares on the secondary market, but liquidity is not guaranteed.

Final Thoughts

A critical strategy when it comes to investing, the importance of diversification cannot be understated. There are ways to diversify your portfolio across public and private markets, and further across industry, company stages, geographic locale, and asset classes. By diversifying portfolios, investors may be able to mitigate some of the inherent risks that come with investing.

Are you ready to diversify your portfolio with private market investments? Sign up for a MicroVentures account to start investing!

Want to learn more about investing in startups? Check out the following blogs to learn more:

• From Private to Public: Understanding the IPO Process
• Understanding Equity Deal Terms
• Common, Preferred, & Convertible: Financial Instruments Explained
• Understanding Secondary Transactions: Right of First Refusal

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The information presented here is for general informational purposes only and is not intended to be, nor should it be construed or used as, comprehensive offering documentation for any security, investment, tax or legal advice, a recommendation, or an offer to sell, or a solicitation of an offer to buy, an interest, directly or indirectly, in any company. Investing in both early-stage and later-stage companies carries a high degree of risk. A loss of an investor’s entire investment is possible, and no profit may be realized. Investors should be aware that these types of investments are illiquid and should anticipate holding until an exit occurs.