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The often-opaque nature of private markets has left some retail investors questioning whether adding these asset classes to their portfolio is right for them. 

With that in mind, let’s look at some key points within private equity that are often misunderstood but important to know.

1. Private equity is more than just buyouts

It is often assumed that Private Equity (PE) covers only buyouts, where general partners (GPs) raise capital in order to purchase mature businesses outright, with a view to improving and selling the company at a profit later on.

As well as buyouts, PE also encompasses two other categories; venture capital and growth equity. Venture investing focuses on backing several early-stage companies looking to scale up and disrupt existing industries. Moonfare’s latest whitepaper dives further into what venture capital can offer.

Growth investments, meanwhile, sit in-between venture capital and buyouts, targeting minority investments in growing businesses that still have room to expand before an eventual exit.

2. Your Commitment isn’t all due up Front

Would-be investors can often be deterred by the relatively high minimums needed to invest in PE. However, PE firms don’t take that full amount at the start; instead, they request committed cash when necessary during the fund’s investment period.

These capital calls, also known as drawdowns, take place as opportunities arise, usually spanning over a period of a few years. Your commitment is therefore spread out over that investment period, rather than due on signing.

This process is mitigated further given that the first distributions from the underlying funds usually occur a few years after the initial investment. Investors likely won’t need to use 100 percent of their commitment, given part of their early distributions will be used to finance capital calls.

3. Leverage is no Longer the Name of the Game

Relative debt levels have come down significantly in the last two decades. Research shows that the average loan-to-value ratio – a measure of the amount borrowed relative to the company’s underlying value – of new PE investments in 2020 was down 15 percentage points compared with deals in 2005.

PE managers have also become much more hands-on with their investments, focusing on operational value creation rather than leverage to drive performance. These strategies can include divesting non-core products, diversification or improving supply chain efficiency.

4. Performance is Measured Over the Long Term

To perform rigorous due diligence on a manager, we need to understand a fund’s vintage – the year the vehicle first made investments – as well as its internal rate of return (IRR) – a measurement that allows potential investors to compare the relative performance of funds or deals across both vintages and asset classes. The IRR covers the fund’s lifecycle, not just the launch year.

Assessing these metrics highlights the potential of PE in modern portfolios. According to McKinsey, the pooled IRR of the top 25 percent of PE funds with vintages from 2008-2018 topped 30 percent, way ahead of similar high performers in other asset classes.

5. Private Equity Liquidity is Increasing

Traditional PE investments involve handing over your capital to a GP for potentially a decade before seeing full returns.

This picture is changing, however. Increasingly, firms are satisfying this demand for liquidity by offering secondary funds, vehicles designed to take existing stakes in companies from investors who would like to exit earlier than would traditionally be possible.

This can be due to a variety of reasons, ranging from personal changes in circumstances or preferring to move the capital elsewhere in the portfolio. According to McKinsey, PE secondary funds raised almost $90 billion in 2020, almost three times 2019’s figure.

  • To read the entire article visit the Moonfare blog, where you can see other insights on how to navigate private markets.

Sources:
1 investmentcouncil.org
2 media.iese.edu
3 www.mckinsey.com
4 mckinsey.com

Important Notice: This content is for informational purposes only. Moonfare does not provide investment advice. You should not construe any information or other material provided as legal, tax, investment, financial, or other advice. If you are unsure about anything, you should seek financial advice from an authorized advisor. Past performance is not a reliable guide to future returns. Your capital is at risk.