Private Equity Investing – Five Questions Answered

Should you consider private equity? How do you access private markets if you want to, and what are the biggest risks? Our experts explain the basics.

We caught up with Tim Boole, Head of Product Management Private Equity, and David Bajada, Investment Director at Schroders Capital, to find out what investors can expect from private assets.

Why might I invest in private rather than public markets?

TB: “Investing in private markets offers a way for investors to diversify their investments. Although not guaranteed, there’s typically a weak relationship between private equity performance and traditional asset classes’ performance – including listed equity – what we refer to as a “low correlation”.

“There’s also the issue of fewer public companies to choose from than in the past. Over the last 20 years or so, we’ve seen a significant decline in the number of new companies listing on the public markets. This is sometimes because the regulatory burden of listing is too much, or because they’re able to access the capital they need privately, more easily.”

DB: “As a private investor there’s also often a greater opportunity to be an active stakeholder. This is because you’re generally one of a few stakeholders – versus a public market investor who is one of many – and usually a majority shareholder. This can mean you have greater insights into the business and can exert a greater influence on the running of the company.

“Managers of private equity investments are often more able to negotiate favourable terms during economic turbulence than shareholders. Furthermore, private equity allows for greater flexibility with regards to the type and timing of company exits.”

Isn’t private equity investing associated with illiquidity?

TB: “Yes, it can be. Liquidity is certainly not the same as when investing in more traditional asset classes. But what we’ve found is that investors often pay for liquidity which they don’t use. So they might invest in a mutual fund because it’s more liquid than a private fund, but they land up staying invested for the long-term and not using that liquidity aspect. In the process, they could be missing out on the potential return opportunities historically associated with private equity investing.

“It also depends on what the investor needs the liquidity for. Is it because the financial markets are stressed and they want to cash out quickly? Arguably, this is the worst time for a long-term investor to sell their assets but yes, it may be difficult to liquidate private investments in this scenario. That said, under normal market conditions, private equity can often be structured in funds that allow for periodic liquidity windows. These provide investors with the flexibility they need for personal situations (e.g. portfolio reallocation or big ticket expenditure, like a new house).

“Finally, technology is fueling an increasingly effective secondary market for private assets. In other words, it’s becoming easier for investors to find buyers and sellers of private assets, as opposed to being restricted to transacting through the manager holding their capital.”

What type of product structures are there?

TB: “I firmly believe that if we want to democratise private asset investing, we have a responsibility to structure products that meet retail investor needs. There has been some meaningful progress on this front.

“For example, there are open-ended semi-liquid funds that allow monthly subscriptions and quarterly redemptions – although a long-term investment horizon is still encouraged. There are also the long established closed-ended listed funds that provide liquidity through the secondary market. These are often suitable for investors with high liquidity needs.

“And there’s the option of close-ended funds in which your money is essentially inaccessible for the investment period (typically 5-10 years), but the minimum investment amounts are within scope of mass affluent investors.

“The main issue is ensuring investor suitability and that is why the products are distributed through intermediaries.”

How are private equity funds typically valued?

DB: “Investments in private equity funds are valued at the most recent net asset value (NAV) reported by the private equity manager and adjusted for cash flows activity.

“Fair value adjustments are made to the valuations received from managers in the event of changes affecting underlying holdings. Changes may include currency movements, distributions, material changes in the circumstances of underlying companies or significant movements in public markets.

“Direct investments in private equity are valued in accordance with generally accepted valuation principles and procedures. The valuation methodology will be based on either:

1. A market approach (based on the value of comparable entities, applying a multiple)
2. An income approach based on the cash generated by the relevant entity
3. A ‘milestone’, event driven approach, applicable to companies that will not generate income or cash flows for the foreseeable future or
4. A combination of the above

“Where a direct private equity investment is held alongside a sponsor – the fund’s initiating manager or team –  the sponsor’s valuation will be considered in the valuation process.”

What are the biggest risks associated with private investing?

TB: “It’s critical, as with an investment of any sort, that the investor fully comprehends what they’re committing to.

“Arguably most important is that investors take the time to understand what liquidity constraints exist. In other words, how frequently are they able to buy and sell the private asset or units in a fund. This is where an adviser can play a crucial role in helping investors articulate their investment objectives and risk tolerance, to ensure private asset investing is the right route for their circumstances.

“Ideally, a private investor is willing and able to adopt a long-term investment horizon and is not easily spooked by panicked markets.”

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Originally Posted on November 2, 2021 – Private Equity Investing – Five Questions Answered

The views and opinions contained herein are those of Schroders’ investment teams and/or Economics Group, and do not necessarily represent Schroder Investment Management North America Inc.’s house views. These views are subject to change. This information is intended to be for information purposes only and it is not intended as promotional material in any respect.