As transparency and access improve, mainstream investors are waking up to private equity’s enormous potential.
Typically, investors associate private equity funds with mysterious behind-the-scenes deals or – worse – buying companies using excessive debt and slashing costs to achieve an inflated return.
But as with the earlier stage venture capital industry, the private equity sector has greatly matured in terms of governance practices and the quality of investments.
Once the preserve of institutions, private equity has become more accessible to individual investors seeking to expand their horizons from the short-termism of public markets.
Private equity refers to funds that either invest in undervalued private companies, or buy out public ones. The private equity approach is all about actively managing an underperforming business to increase the value of the asset.
Private equity funds usually hold the asset for a set period, before attempting an initial public offer (IPO) or trade sale. The ‘closed end’ structure means that investors commit a specific amount of capital and then receive distributions as assets are sold along the way.
This is a key difference to an ‘open-ended’ fund, by which investors remain fully invested until they choose to redeem.
According to LGT Crestone senior investment specialist (alternatives) Martin Randall, private equity enables investors to access a far greater array of businesses and sectors.
“You have this huge opportunity relative to the public market, which is shrinking,” he says.
The trend is borne out by numbers from the US-based private market specialist Hamilton Lane: currently there are 18,000 US private companies with turnover of more than $US100 million, compared with only 2800 public companies of that size.
What’s more, there were 7800 US listed companies in 2000; now there are only around 4800.
Randall says companies are staying private for longer, while more public companies are deciding to go private via buy outs or mergers.
“You will still have the monster stocks that are public, but increasingly we will see this value creation shift from public to private market,” he says.
“Companies are staying private for longer, while more public companies are deciding to go private via buyouts or mergers”
Locally, a private-equity consortium acquired revered retailer Myer and floated it in 2009. The deal was great for the vendors who made six times their money but a disastrous one for subscribers to the IPO, which famously had model Jennifer Hawkins on the prospectus cover.
But such window dressing of assets – literally or otherwise – seems long gone. The latest local private equity ASX buyout – Allegro Fund’s intended $150 million purchase of Slater & Gordon – looks more a case of taking the long-underperforming law firm quiet so the restoration can be done away from the public market’s unhelpful gaze.
Randall says private equity owners increasingly are encouraging CEOs and other top executives to contribute equity so their interests are aligned. Their remuneration is not tied to meeting a quarterly profit target, but to long-term outcomes.
Unlike with public companies, the directors are relevant specialists.
“Everyone is focused on getting the best possible outcome to grow that company to get a better exit for underlying investors,” he says.
Randall says the time frame for private equity investment is becoming elongated, partly because companies are choosing to stay private for longer. In other words, they are choosing not to IPO because of market conditions and the pressure imposed on listed companies to achieve short term returns.
While a fund typically might have a 10-year horizon, the individual investments are typically ‘repaired’ within two to three years.
“Most committed capital is back by the sixth or seventh year and investors might get some early distributions within three to four years,” he says.
As asset values become less frothy after a turbulent 2022, private equity acquisitions are likely to re-spark after a quiet patch.
Perversely, good private assets are likely to become available because of private equity’s outperformance.
As Randall explains, an institution’s mandate might determine an asset allocation of 50 per cent to equity, 30 per cent to bonds and 20 per cent to private equity.
If the private equity component increases beyond 20 per cent because of relative outperformance, these institutions are required to rebalance their portfolios.
“For us it is good opportunity to pick up some really high-quality deals being sold less for financial reasons, but to readjust portfolios.”
A global wealth manager, LGT Crestone has addressed the obstacles preventing individuals from accessing private equity. In a similar vein, Hamilton Lane refers to the “democratisation” of private equity.
One challenge is that the closed end nature of private equity funds means they have not been open to new capital and are illiquid. But financial technology advances now allow for semi-liquid open-ended structures, enabling inbound liquidity and redemptions.
Hamilton Lane CEO Mario Giannini concurs that while private equity has enormous potential, it is an entirely new frontier for many individual investors.
“This is a very challenging asset class,” Giannini says. “For us it means bringing you products that give you ... great access and great terms and doing it in a way that prevents some of the headaches of private markets investing.”
Given private equity has a long history of outperforming the public market, those headaches might well be worthwhile.
While the public-private comparisons are not straightforward, Hamilton Lane estimates that private equity globally achieved a 15-year compound growth rate of just over 12 per cent per annum, outperforming the S&P 500 index by at least 300 basis points.
