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Rebalancing a Private Investment Portfolio

Rebalancing a Private Investment Portfolio

When investing in private companies, investors may be interested in rebalancing their investment portfolio at various points in time. However, private market investments are inherently illiquid and positions cannot be bought or sold as quickly as public investments like publicly traded stocks. Therefore, an investor seeking to rebalance their investment portfolio needs to look at the process differently for private investments than public investments. In this blog, learn more about how you could rebalance a private investment portfolio, the importance of due diligence, the possibility of secondary sales, and some key considerations for investors.

Rebalancing a Private Investment Portfolio

Why Traditional Rebalancing Doesn’t Work

When investing in public markets, portfolio balancing is typically straightforward.  If one asset class isn’t meeting your expectations, an investor can sell part or all of it and retarget that money into investment opportunities that may align closer with portfolio goals.

On the other hand, private market investments aren’t able to be bought and sold quickly or easily. Private investors are subject to long holding periods, typically until company failure or exit like an initial public offering (IPO), acquisition, or a merger. So, what should an investor do when they are interested in rebalancing their investment portfolio?

Secondary Sales

There is the possibility to exit a private market investment position through secondary sales. These occur when the original investor, whether a founder, early employee, or early investor, decides to seek out a qualified buyer to purchase the shares. However, secondary sales are rare to pursue, can be expensive, and often come at discounted terms than the original investment, meaning traditional portfolio rebalancing strategies don’t apply.

So, how can investors help mitigate risk and maintain a balanced investment portfolio if they aren’t able to exit positions quickly and easily and secondary sales are rare and can be expensive? The answer may lie in proactive due diligence and diversification principles.

Due Diligence & Diversification

Since investors cannot easily exit private investments, one way to avoid future imbalances is to be highly selective from the start through due diligence and diversification tactics.

1. Avoiding Overconcentration in Single Deal

No matter how innovative or promising a startup is, investors should resist the temptation to put significant amounts of their investment allocation into a single deal. Diversifying a portfolio across multiple investment opportunities can help investors mitigate risks.

2. Evaluating Sector and Stage

If an investor’s portfolio is heavily weighted towards fintech, they may want to consider diversifying in other sectors like healthtech, artificial intelligence, or consumer-packaged goods. Additionally, investors can help balance their portfolio with earlier-stage startups and later-stage companies.

3. Assessing Liquidity Timelines

With the knowledge that private market investments are inherently illiquid, if investors anticipate needing access to any capital sooner, they may want to focus their portfolio on later-stage companies that have already publicly spoken about potential exit opportunities. However, even later-stage companies discussing IPOs can still fail. No investment returns are ever guaranteed and if investors need access to capital in the near future, they probably shouldn’t be investing in private market opportunities.

Rebalancing Through New Opportunities

Since private market investors don’t have the ability to quickly buy and exit positions, how can investors rebalance their existing portfolios? One approach is being selective with new opportunities in an attempt to rebalance a portfolio.

1. Reassess Current Exposure

Investors can map out their existing investors to understand their current exposure levels. For example, investors could list off their current portfolio companies by sector (industry), stage (how mature is the company), and geographic region (where the company is founded and where it operates). From these lists, investors can identify gaps in sector, stage, and geographic region within their portfolio and add new portfolio companies that fill in those gaps in an effort to diversify.

2. Double Down on What’s Working (Carefully)

If a particular sector is performing well in terms of venture investments, exits, and favorable government regulation, investors may want to increase their exposure to that sector. However, investors shouldn’t increase their exposure to the point of overconcentration. For example, if investments in AI are performing well and mergers and acquisitions in that sector are strong, one more AI investment could make sense. However, 10 more AI investments may not make sense.

3. Consider Fund Structures for Built-In Diversification

Investing in venture capital funds are another option for private market investors looking to diversify their investment portfolio. These funds typically spread capital over a variety of startups that meet specific criteria of the fund’s investment thesis. For example, one fund may focus on pre-IPO later-stage companies and invest across 3-5 startups that meet that criteria, despite which industry the startups operate in. Another fund may focus on AI startups, without focusing on the stage of the company. These funds may provide less manual diversification than investing in individual opportunities.

Final Thoughts

Despite rebalancing not being available for most private market investments, there are ways that private market investors can help to balance their portfolios by using up front due diligence and diversification tactics when adding new investments. By focusing on strong due diligence and diversifications, private market investors may be able to craft a balanced portfolio that aligns with their interests, goals, and objectives.

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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.