It may seem that private equity investors already own everything: fashion brands, food companies, computer companies, and even football clubs and startups.
And still, the number of private equity transactions remains at a high level. But what are the options for private investors to benefit from this asset class?
Jan Lazar, a seasoned private equity expert and senior advisor with a long track record in private markets and wealth management, shares with us his insights on private market investment strategies.
Thank you, Jan, for taking the time to chat with Centro LAW. Tell us a bit more about your field of expertise.
I have dealt with a wide range of alternative investment products for many years, mainly within the private market space, and I combine this with good knowledge of the wealth management industry.
My focus is product development and platform management, and investor relations in the private market asset class.
Private market investments informally referred to as private equity, are today essential for strategic allocation in a well-diversified wealth management portfolio.
Private equity exposure provides investors with an additional and valuable alternative source of performance over time. Thus, investors who only focus on public markets miss a growth opportunity and should consider private equity.
Since sophisticated private investor demand has been thriving, wealth managers built specialized capabilities to address it. And, over the last decade, we have seen a private equity hype in wealth management.
Furthermore, recently, fintech platforms entered the market and aim to democratize the asset class by offering investment opportunities to a broader range of investors with new disruptive client access and experience.
These platforms allow for access to pre-curated private equity investments or even direct deals by cutting out the incumbent middleman. They are disrupting the market with some private equity platforms already competing with large, established institutions.
Can you give us a quick overview of the type of investments available for private wealth owners?
We can generally distinguish two primary investment structures: indirect investments with investment funds and direct exposure to private companies or projects.
Indirect investments are structured generally as a limited partnership through investment funds, funds-of-funds, or managed accounts. In most cases, the investors are limited partners.
The general partner acts as the responsible fund manager for deal sourcing, deal selection, due diligence, transaction execution, and reporting in a governance model framework.
These delegated tasks and services come with a price: management and performance fees and setup and operational costs.
With direct private market investments, which are not vetted and approved by fund managers, the investors become shareholders, partners, associates, or creditors in direct private debt investments.
The challenge is to identify great ideas and investment opportunities, curate a professional network for steady deal flow and conduct due diligence and investment execution on a deal-by-deal process since no fund managers are involved.
Outside a fund structure, direct investors might save on management fees and costs. However, they also bear the deal costs and relatively higher risk on a single investment due to a lack of diversification.
Beyond the mere returns, direct investments come with the benefit and learning curve of personal involvement and more transparency.
How do you build a private equity portfolio? What are the benefits, and where do you get independent specialist advice?
Like institutional investors, private investors should devote capital consistently over time to build their target allocation.
In my experience, the four pillars of a diversified portfolio are investment strategies, sectors, geographies, and maturities, also called vintages. For fund investments, the fund manager selection is an additional pillar to consider.
To build a balanced direct investment private equity portfolio is indeed tricky. Committing capital to a successful private equity fund might be economically more attractive and more straightforward than investing on a deal-by-deal basis.
However, combining both strategies might help to diversify portfolio risks. Sometimes, private investors and family offices are well organized, rely on expert teams, and take a sophisticated and professional investment approach.
Direct investments have other benefits than fund investments, and those go beyond higher returns.
I believe in a balanced portfolio and the right mix of direct investments with high-quality niche funds. Such a hybrid approach may be the best way to address diversification: it leverages the best of wealth managers' expertise with in-house private equity teams, fund managers directly, and independent advisors.
Specialized independent advisors can assist in portfolio allocation, market screening, due diligence, structuring, execution, portfolio management, and reporting.
Such independent experts and investment boutiques are also a valuable consideration for specialized investments. These, for example, provide excellent value for sustainable and impact investing, an absolute priority that has not yet entirely reached industry mainstream.
What performance should you expect in private markets? And what about the associated risks and costs?
Private equity markets outperform the public markets over long-term time horizons, as among others, they compensate for the fact that they are illiquid. Investors need to have an investment horizon from 6 to 12 years.
Due to the asset class's illiquid nature, you may not exit during the investment period. Although there are secondary funds and investors, which can provide some liquidity, this usually comes with the high price of a substantial discount.
The transfer of a limited partnership interest is restricted and requires the general partner's consent, but this is the price for potentially higher returns.
Another characteristic of private equity is the timing of capital flows. When investors commit capital to a fund, it is not drawn down upfront by the general partner.
On the other hand, direct deals and co-investment opportunities are fully paid upfront. Private equity funds call capital on an as-needed investment basis only.
Furthermore, the exact investment exit timing and liquidation are unknown, and the profit generation is neither. In other words, the time and amounts of distributions are not known in advance.
Private equity requires patience and the ability to deal with irregular capital flows, both when paying or receiving capital.
Transparency is another field where private equity differs from traditional investments. Private equity funds invest in unlisted companies that usually have limited disclosure requirements.
This means that only the fund manager, but not necessarily the investor, has detailed insight on the state of the underlying investments.
Furthermore, only the fair market value is reported, and the fund manager determines this value. The realized overall performance is nevertheless real and is reported and distributed once the investment is liquidated.
There are significant costs associated with private equity. Private equity funds charge fees for setup, management, due diligence, and performance (carried interest).
Additional costs include those for uncalled committed capital and random distributions since part of the cash can stay idle until a new investment opportunity is ready to go.
In general, what advice would you have for wealth owners who want to invest in private equity? How is the industry currently positioned?
The number of publicly listed companies in the US has decreased by approximately 50% over the last two decades. This development is an opportunity in private markets.
Private equity is on a long-term growth trend, and there seems to be little that will stop it soon. It is also an essential contributor to value creation in the real economy and investors' portfolios.
Therefore, interest in private equity is and will most likely remain strong. According to recent research, most investors in private markets expect to increase their allocation to the asset class.
Also, new investors' capital will flow into the asset class. This upward trend is fueled by the increasing interest in sustainable and impact investments, as the majority are venture capital, private equity, and project finance investments.
Direct investments and private equity funds are only accessible to few private investors due to high entry barriers, such as minimum investments, access to fund managers, and good deal flow. A possible solution for private investors is to build exposure through funds of funds with reduced investment threshold to enable portfolio diversification.
Timing is another consideration. Due to the long holding period, which might extend over several economic cycles, it is advisable to invest with a certain regularity and to establish an investment plan over time to build a balanced risk diversification level.
It is crucial to diversify across different investment managers and styles, different company development and financing stages, and across sectors and geographic regions.
Finally, a careful analysis of a fund manager and its team's track record and expertise are vital.
About Jan Lazar
A senior business executive and product management specialist, Jan has wide-ranging private market expertise. He is an alternative investment product, platform, and development expert. Furthermore, he acts as senior advisor to the swiss impact office™, a Zurich-based investment specialist that develops sustainable and impact investing strategies and allocates institutional and private capital to diversified portfolios with a high impact profile.
14-10-2020