Private-equity funds fell firmly out of favour in the wake of the global financial crisis. But now there are signs investors are returning to the sector. We don’t think you should join them.
Private-equity firms come in many guises but most use debt to finance management buy-outs or takeovers of underperforming firms. In the process they may take a once public firm into private ownership. They then reorganise them, invariably by stripping out costs, hoping to boost profits. A few years later they will look for an exit (this may involve a return to the stockmarket), having earned a healthy return on investment.
For a retail investor, a private-equity fund is thus often a way of investing in assets that aren’t publicly listed. This can open up otherwise inaccessible investment opportunities. But it’s risky. For example, there may be minimum lock-in periods that make any investment pretty illiquid. Any payout to investors may take years to arrive, or be deferred if a fund is short of the necessary cash to meet redemption demands – a problem immediately after the credit crunch, as many investors all tried to sell at once.
Nonetheless, half of the wealth managers questioned in a survey by wealth managment consultancy Scorpio Partnership and industry association LPEQ stated that they planned to increase their private-equity allocation this year. “Listed private equity is trading at discounts of around 25%, there is an increase in cash flow and mergers and acquisitions,” says Charles Cade of Numis Group in The Daily Telegraph. “It is still risky, given the global economic environment, but there is a lot of value there.”
This “could mark the end of a difficult couple of years” for the sector, says Emma Wall in The Daily Telegraph. Having plummeted a few years back, since 2009 fund net asset values have been slowly recovering. The purchase last week of RAC by asset management group Carlyle “has been heralded as a return to form” for the industry, says Wall. Another attraction is that many private-equity funds are now “mature”, says analyst Iain Scouller of Oriel Securities in the FT. This means that realisations – where a fund sells holdings to fund payouts to investors – should start to pick up.
However, we still see this as a very volatile sector and only suitable for those with spare capital and the will to stomach losses. Tom Beckett, chief investment officer at PSigma, agrees: “I regard private equity as very high risk”, he says in the Financial Times.