Private equity rewards investors with time and patience

Several weeks we noted that there are changes afoot in the high-net-worth portfolio. Simply put, high-net-worth individuals (HNWIs) are shifting out of fixed income and allocating to other assets. One of those preferred assets is private equity.

Over the past several quarters, allocation to private equity among Aevias Worths’ members has risen to 18 per cent of the total portfolio (a little under two years ago, it stood at 9 per cent). That’s a fairly sizable allocation, and a pretty dramatic rise of 100 per cent.

So what is private equity, and why are the wealthy so interested in it? And, perhaps most important of all, is there anything the “average investor” can learn from this trend?

As the name suggests, private equity is an equity investment in a business that is not publicly traded. The exact form of that investment can vary. It could be the direct purchase of an operating business (anything from an Internet start-up to a century-old manufacturing business). It could also be an investment in a fund, ETF or closed
“pool.”

Truth be told, many HNWIs prefer private businesses to publicly traded businesses. The vast majority of them are or have been business owners themselves, so they understand the different dynamics at play, and the opportunities in privately held business that aren’t readily available in publicly traded equities. But there’s something else here too. HNWIs are beginning to sense a change in the air – that the growth prospects
of privately held businesses currently seem more compelling than those in publicly held businesses.

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. Its value is not affected by daily issues that impact public securities. Growth in value is driven by managers of the businesses whose interests are closely aligned with the interests of investors.

Another positive: private equity can offer great returns; for over 25 years [private equity] has performed better than public equity.
Still, isn’t private equity a risky business? The old saw is that for every start-up that succeeds, there are nine others that fail – what do private equity managers do to ensure investors are on the right side of this equation?

In actual fact, start-ups are a very small part of the private equity world. They are high profile when they succeed so people think of early stage venture capital as being private equity; but it represents less than 10 per cent of the private equity landscape.
“Because they are less exciting, most people don’t talk about good companies purchased for five times cash flow.

Those businesses are often sold to large corporations looking to expand by acquisition, and investors make two three times their money in a quiet private sale.”

But still, isn’t there some risk by investing in things that are outside public scrutiny?

The risk in the private equity is not greater than the risk in the public equity market, but it is different, 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.