Several weeks ago, I noted that high-net-worth individuals (HNWIs) are shifting out of fixed income and allocating to other assets. One of those assets is private equity.
Over the past several quarters, allocation to private equity among Tiger 21 members has risen to 18% of the total portfolio (two years ago it stood at 9%).
Many HNWIs prefer investing in private businesses. Most of them are or have been business owners themselves, so they understand the opportunities in privately held business can be superior to those in stocks.
As the name suggests, private equity is an equity investment in a business that is not publicly traded.
I recently spoke to Tom Kennedy of Kensington Capital Partners about private equity. He’s the managing director and chairman of the investment committee at one of the more successful private equity/hedge fund firms in the country. The firm has placed more than $550 million to private equity investments over the years and is also the manager of the successful Kensington Global Private Equity Fund. I asked Kennedy: why would you want to invest in private equity?
“Private equity grows in value in a less volatile and more consistent manner than many other asset classes,” he told me.
Another positive: private equity can offer potential for great returns. As Kennedy pointed out, over the past 25 years, the Cambridge Associates U.S. Private Equity Index has returned an average 13.10%. By contrast, the S&P 500 Index has returned 8.62%. That’s quite a difference. Still, isn’t investing in startups risky?
Kennedy told me that they are a very small part of the private equity world.
“They’re high profile when they succeed, so people think of early stage venture capital as being private equity,” he said. “But it represents less than 10% of the private equity landscape.”
Is there something about the current climate that makes private equity particularly compelling?
“In this environment, sellers’ price expectations are realistic, so it is possible to buy well,” Kennedy said. “Financing is inexpensive as well, so the overall cost of ownership is good.”
All in all, a pretty compelling case for private equity “with modest economic growth it is possible to build businesses so value creation is underway in this environment.”
Interested in putting some of your money to work in private equity? Here are some quick tips:
•Patience is key
Private equity is a long-term asset for those looking for long-term appreciation. If you can’t wait at least five to seven years before seeing a payoff, take your money elsewhere.
•Not all private equity is created equal
Don’t assume private equity is a one-size-fits all investment – a private equity investment could be a venture capital/startup situation or just as easily an established business. Figure out which side of the game you want to play on.
•Management, management, management
When you invest in private equity, you’re really aligning your interests with management. So get to know them. Understand their vision for the business. Find out how they intend to increase value.
•Diversify
There’s no reason why you need to put all your private equity “eggs” into one basket. There are some good ETFs operating in this space and some very good funds and pools run by professional managers. They’re worth checking out.
Kennedy also said, “The risk in the private equity is not greater than the risk in the public equity market, but it is different. Have prudent diversification, concentrate on quality, intensive due diligence, and watch your investments carefully to be sure you know what is going on with your portfolio.” •
