In an environment of low yield and at-best moderate returns, investors are increasingly looking beyond bonds and shares to find meaningful return.
Some are looking to private markets; not an easy asset to invest in, but potentially a valuable alternative to more traditional routes.
Private equity investors essentially provide capital for businesses that are not listed on a stock exchange. Those funds might be used to – among other things – develop new products and technologies, help the company expand overseas or to grow by buying out competitors or forming partnerships.
As an asset class, private equity has outperformed stocks, bonds, hedge funds and listed property over the long term. According to the British Private Equity & Venture Capital Association, its member funds generated an annual return rate of 13.2 per cent over the 10 years to 2015, compared with just 5.6 per cent for the FTSE All-Share index.
Unfortunately, private equity is difficult for individual investors to access, mainly due to high initial investments, from $250,000 to millions of dollars, and relatively long lock-up periods for your capital – typically up to 10 years.
That’s why, traditionally, private equity has been the domain of institutional investors such as banks and super funds, or very wealthy individuals – think the Packers, Pratts and Murdochs of the world.
However there are ways for smaller individual investors to access private equity; via private equity managers or through a “fund of funds” (or multi-manager) vehicle, for example.
All those options are relatively complex and probably not for those who are heavily reliant on cash flow, so before making any decisions ask your financial adviser about the best way to add private equity exposure to your portfolio.
Finding return in low yield environments can push you outside your comfort zone for good reason. Mercer Financial Advice is always available to help you make informed decisions for your needs. Call 1300 850 580
What advantages does private equity have over public shares?
Private markets investment requires investors to tie up their capital for up to 10 years, adds to their compliance burden and usually comes with additional fees and costs; so why would anyone do it?
Because private markets provide “return drivers” that are simply not available elsewhere. These return drivers might offer greater compensation for risk or they can help investors diversify their portfolio.
The primary return drivers available to private markets investors include:
Because an investor is locking up substantial capital for a long period they can expect to be compensated. The illiquidity premium is an excess return that compensates an investor for supplying capital that cannot be easily liquidated at short notice.
This concept has a strong intuitive appeal as the average investor values the flexibility provided by assets that can be quickly turned into cash.
In the same way, investors should and do expect some compensation for investing in more complex transactions.
If a given transaction involves more complexity than a typical public markets investment this will naturally reduce the number of investors willing to participate in the deal, so those that are willing to undertake the necessary homework – which could include significant legal expertise – can expect additional return.
Hands-on value creation
Private markets investors have a significant “hands-on” advantage because they typically have a much greater degree of control over the underlying assets – a real estate investor can refurbish a property for example – so they can directly create higher value and expected levels of return.
Who invests in private equity?
Wealthy individuals – with very assets measured in the millions – may invest directly in companies that need capital. This is out of reach for most investors.
Managed private equity funds – private equity managers collect capital from investors – wealthy individuals, companies, banks, super funds – and invest those pooled funds in private companies. Minimum investments can be high – around $250,000 – so these too fall beyond the reach of most.
Fund of funds – These invest in a portfolio of private equity funds – anything from half a dozen to several dozen funds spread across a range of managers and geographical regions – providing investors with access to a variety of private companies. Minimum investments can vary but the cost is a fraction of direct investment, bringing this option within reach of many private investors. An additional layer of management does mean additional fees which eat into your real return, but it’s the price of access to what would otherwise be out of reach.
You can purchase shares of an exchange-traded fund (ETF) that tracks an index of publicly traded companies that invest in private equities. Since you are buying individual shares over the stock exchange, you don't have to worry about minimum investment requirements.
Ask a Mercer financial adviser about the best way to add private equity exposure to your portfolio, call 1300 850 580.