InvestmentsSep 5 2016

Newly accessible sector catches investors’ eyes

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Newly accessible sector catches investors’ eyes

Private equity has delivered average returns of 14.9 per cent over the past 10 years, with the small buyout sector being the best performer of the market.

Private equity should not be confused with investments made by venture capital investors. While both investment types are made into private companies, venture capital investments are made into early-stage, normally pre-profit and often pre-revenue businesses.

While these businesses have the potential for generating high returns, they also carry a commensurately high risk. Instead, private equity investments are made into pre-existing, often long-established companies, usually involving the buyout of one or more shareholders.

While institutional investors have been allocating 5 per cent or more of their assets to private equity for many years, it is only relatively recently that high-net-worth and sophisticated private investors have been attracted to the asset class.

Private equity investments are made into pre-existing, often long-established companies, usually involving the buyout of one or more shareholders Michael White, YFM Equity Partners

Among the high-net-worth market, entrepreneurs have embraced private equity the most. Successful entrepreneurs are typically business savvy and highly driven individuals, with a clear vision of what they want to achieve.

But for most, there always comes a time to sell their company, whether it be when all their goals are achieved, they want to retire, or someone offers a price that’s too good to refuse.

So what happens next? Taking a long holiday might come first, but that’s the easy bit. When the suntan has faded there is a real job to be done: how to invest the £50m, £100m or more they have realised, which is no small task – albeit there are plenty of advisers on hand to help.

Investment in property and a portfolio of stocks and bonds will no doubt form part of the solution, but entrepreneurs, who may already have personal experience of the power of private equity to fuel growth, will often set aside a ‘play pot’ for investing in small businesses, often taking 100 per cent ownership and becoming actively involved.

The problem with this ‘direct’ private equity approach is that once you have invested in a few businesses you can soon run out of bandwidth to manage these investments, and you end up with a relatively high concentration of funds invested in perhaps only three or four companies.

There are several reasons, then, why investing in a private equity fund in addition to, or in place of, direct investing makes sense:

• Diversification, with a typical private equity fund investing in 10-15 different businesses, across a range of sectors;

• Access to a wider level of deal flow;

• Professional management, by a team with a demonstrable and consistent track record;

• Fund managers often offer investors access to co-investment opportunities, so they can ‘double up’ on investments of particular interest, with the added benefit that these will have already been through professional due diligence;

• No personal involvement required, but investors will typically get regular progress reports, be able to attend AGMs, hear from portfolio company chief executives and could even have a role on the funds’ advisory panel, although this is usually reserved for larger investors;

• The social and personal satisfaction of helping grow British businesses.

Private equity has long been the preserve of the institutional investor, but a combination of fund managers making it accessible to high-net-worth and sophisticated investors, along with the attractive returns it offers, have put it firmly on the radar as an alternative asset to be considered as part of an investor’s portfolio.

Michael White is a director at YFM Equity Partners