Public vs. Private Equity Securities

Investment Characteristics:

• Public Equity: Offers easier market entry and exit, and is subject to market fluctuations and transparency.
• Private Equity: Provides potential for higher returns due to illiquidity and limited access, with a focus on long-term growth and strategic development.

Public Equity Securities:

• Market Size: Significantly larger than private equity markets.
• Regulation: Highly regulated to protect less sophisticated investors.
• Corporate Governance: More effective due to public scrutiny.
• Liquidity: High liquidity with active secondary markets; securities can be easily and cheaply sold at market prices.
• Disclosure: Requires extensive public disclosure and regular reporting.
• Investment Access: Accessible to a wide range of investors.
• Investment Types: Includes stocks listed on major exchanges.

Private Equity Securities:

• Market Size: Smaller compared to public equity markets.
• Regulation: Less regulated, with fewer disclosure requirements.
• Corporate Governance: Less formalized compared to public firms.
• Liquidity: Highly illiquid; often traded through negotiations and private deals.
• Disclosure: Limited public disclosure; more private and confidential.
• Investment Access: Typically available to accredited or institutional investors.
• Investment Types: Includes venture capital, leveraged buyouts, and private investments in public equity (PIPEs).

Question

Why might a pension fund decide to increase its allocation to private securities and reduce its allocation to public securities?

1. To increase the fund’s expected return.
2. To reduce overall transaction costs and management fees.
3. To increase the fund’s liquidity in order to pay out future short-term obligations.

Solution

The correct answer is A.

Private securities often offer higher potential returns compared to public securities, compensating for their lower liquidity and higher risk. Pension funds may seek to enhance overall returns by investing in private equity, which includes venture capital, leveraged buyouts, and other high-growth opportunities.

B is incorrect. Private securities often come with higher transaction costs and management fees compared to public securities. Increasing allocation to private securities might actually increase these costs rather than reduce them.

C is incorrect. Private securities are generally less liquid compared to public securities. Increasing allocation to private securities would reduce the fund’s liquidity, not increase it. This approach is not typically chosen if the goal is to enhance liquidity for short-term obligations.