Chapter 3 Part 1: You're Already Investing in Private Equity (You Just Don't Know It)
Here’s something most people don’t realize. If you have a pension, pay insurance premiums, or even have a retirement savings account, there’s a good chance some of your money is sitting in private equity right now. You didn’t choose it. Nobody asked you. But that’s how the system works.
Chapter 3 of Demaria’s book opens with this exact point. We are all investors in private markets, even if we don’t know it.
Where Does the Money Come From?
The big players in private equity are institutional investors. These are organizations that collect money from regular people and then decide where to put it. We’re talking about pension funds, insurance companies, banks, endowments, and sovereign wealth funds.
Think of it this way. You pay your insurance premium every month. That money doesn’t just sit in a vault. The insurance company takes it and invests it across different types of assets. Some of it ends up in private equity funds.
Same story with pension funds. Future pensioners contribute regularly, and the pension managers invest that money long-term. Private equity is attractive to them because pension funds need high returns over decades, and PE historically delivers that.
Then you have endowments. Harvard and Yale have more than 25% of their assets in private markets. Ivy League endowments generated roughly 45% of their returns from PE and hedge funds in the early 2000s. That’s a big number.
Family offices manage wealth for rich families. High net worth individuals can invest directly or through private banks. Sovereign wealth funds like Singapore’s Temasek also play in this space.
As of 2018, institutional investors typically allocated between 0.4% and 3% of their assets to PE, depending on the type of investor. European pension funds averaged about 3.7% in 2010. Not huge percentages, but when you’re managing billions, even 3% is a lot of money.
Three Ways to Get In
Demaria lays out three channels for investing in private companies.
Direct investment. You put money straight into a company. This is what crowdfunding platforms and angel investor clubs do. Some countries offer tax incentives for this. But it’s also the riskiest path. Start-ups have a very high failure rate, and most individual investors don’t have the expertise, time, or network to do proper research on private companies. There’s a 30% chance of losing everything on a direct US start-up investment. But there’s also a 25% chance of getting 5x or more return. High risk, high reward.
Through a fund. This is the most common path. You give money to professional fund managers who pick the investments for you. Some funds are generalist, covering venture capital, growth, and buyouts all at once. But the best-performing funds tend to specialize. Index Ventures in venture capital. CVC or EQT in buyouts. Sequoia Capital in IT. The logic is simple: investing in private companies takes deep expertise, and you can’t be an expert in everything.
Through a fund of funds. This is a fund that invests in other funds. Groups like HarbourVest or Partners Group run these programs. The idea is shared expertise and broader diversification. The downside? Extra layer of fees. And as the market has gotten more transparent over time, the edge that funds of funds used to have has shrunk. Many have started co-investing directly alongside their funds to cut costs and boost returns.
Why PE? The Risk and Return Story
Two words: diversification and returns.
Private equity gives investors access to things the stock market doesn’t. Venture capital covers emerging sectors like biotech, nanotech, and fintech. Many of these companies are not listed anywhere. LBOs cover narrow industries that the stock exchange barely touches. Think chemical companies, aerospace, or even funeral homes. PE also covers emerging markets and companies at every stage of life, from brand new startups to companies that need to be turned around.
Here’s an interesting point from the book. Volatility, which is how most people measure risk in stocks, is basically meaningless for private equity. PE assets are not listed, so there’s no daily price bouncing around. Does that mean PE is low risk? No. It means volatility is the wrong tool to measure risk here. A better measure is: what’s the probability of losing money, and how much could you lose?
Because PE has low correlation with public markets, adding it to a portfolio reduces overall risk. At least in theory. In practice, PE is still connected to the stock market. Valuations reference listed companies. Exits happen through IPOs or trade sales. If the stock market tanks, PE deals get harder too. Interest rates and GDP growth also matter.
On returns, the book cites research showing PE outperforms stock indexes by 500 to 800 basis points (that’s 5-8% extra per year). Annual returns for direct company investments typically land between 12% and 20%. Most fund investors in 2017-18 expected net returns of 11% or higher from their PE portfolios.
But here’s the catch. As more money has poured into PE (from about $100 billion in 1990 to $3.2 trillion in 2018), returns have gone down. More competition, more auctions, higher prices paid for companies. The easy money is gone.
Different Investors, Different Goals
Not everyone invests in PE for the same reason.
Insurance companies actually like the early losses in PE (the “J-curve” where returns dip before rising). Why? Because those paper losses help them keep money untaxed in their accounts for future payouts. They prefer predictable cash flows and tend to invest in LBOs and growth capital.
Banks used to be big PE players but got squeezed out by regulations. Basel III rules make PE investments expensive in terms of capital reserves. Most investment banks spun off their PE arms and went back to advisory roles.
Pension funds are long-term investors by nature. They collect money now and pay it out decades later. PE fits this timeline perfectly. The illiquidity that scares other investors is not a problem when your time horizon is 20-30 years. However, pension funds face the “denominator effect”: when stocks crash but PE values stay flat, suddenly PE looks like too big a share of the portfolio on paper.
Endowments and family offices tend to chase absolute returns. They lean toward venture capital and are sometimes hands-on, sitting on boards or advising portfolio companies.
The Hidden Costs Nobody Talks About
Demaria makes a sharp point about large pension funds being “universal owners.” Their asset pools are so massive that the same company can appear in multiple parts of their portfolio. A PE fund buys a startup, grows it, and sells it through an IPO. Now it shows up in the pension fund’s public equity portfolio. The company just moved from one pocket to another, but the pension fund paid fees at every step.
Quick flips, leveraged recapitalizations, secondary buyouts, delisting and relisting. Each of these operations generates fees and costs that pile up. For a universal owner, the real question is not just what return the PE fund generated, but whether actual value was created for the company after subtracting all the friction.
The book argues that PE funds should actually last longer. Selling companies too early (6-12 months too early, according to one study) leaves 18% of additional value on the table. Longer holding periods would reduce the churn and save on costs.
Bottom Line
The main takeaway from Section 3.1 is this: private equity is not some exclusive club for Wall Street insiders. It’s an asset class that touches almost everyone through pensions, insurance, and institutional investments. The money flows from regular people, through institutional middlemen, into private companies.
The system has real benefits. Diversification, higher returns, access to companies you can’t find on any stock exchange. But it also has real costs. Layers of fees, illiquidity, and complexity that most people never see.
If you want to understand where your retirement money goes, this chapter is a good place to start.