Individuals seek access to the private equity club

With many asset classes struggling to provide healthy, predictable returns, the top tier of wealthiest investors are turning in droves to private equity. Yet for this asset to make a serious impact on clients’ portfolios, they must be able to both stomach parting with a high minimum investment and then coping with the lack of liquidity which inevitably follows.

Simon Lamprecht, specialist premium solutions at Bank Julius Baer, notes an increasing interest from clients for alternative investments in general and private equity in particular. “Given the volatile and low-yielding liquid markets, clients seem to increasingly recognise the incremental return potential achievable with less liquid investments such as private equity,” he says. “Risk appetite seems to increase accordingly – in Asia in particular we note a considerably open mind towards private equity.”

Julius Baer recommends private equity as a portfolio component for investors willing and capable to bear the illiquidity and the specific risks associated with these investments.

But with money often locked into an investment for 10 years or more, it is this lack of liquidity that rules private equity out for many private clients, while proving less of an obstacle for institutions.

Entry to the club

Ultra high net worth individuals (UHNWIs) do however have the capacity to get involved. Charlotte Thorne, founder of investment office CapGen Partners, which oversees €1.5bn in assets held by mainly European families, deals with clients who tend to have upwards of $50m (€37m) to invest, and recommends private equity in general mandates.

“Typically we advise our clients to take a ‘barbell’ approach to their asset allocation, so on the one hand we are doing a lot of protection, but once we have secured that capital our clients are looking for a return and private equity can be a really good way to do that, to achieve returns that you cannot find elsewhere in the market,” she explains.

UHNWIs are able to reach the ticket size, have the ability to lock up money for a significant time and may also have access to internal infrastructure enabling them to manage a more complex asset class, explains Ms Thorne.

Different ways to gaining exposure also need to be carefully considered. The traditional private equity fund, where a manager with in-depth knowledge of the asset class runs a number of positions, is often the route private banks recommend clients take, although it often comes with significant fees. High fees are problematic, admits Ms Thorne, but it is important for investors, who often hanker after taking a more direct route, to realise what they are paying for.

“In a private equity fund that is working as it should do, you are paying for the managers to overcome some of the problems that you cannot tackle yourself. Number one is deal flow, and it is really easy to underestimate the value of deal flow. If you are not in the industry and haven’t been doing it for 20 years you just won’t have the deal flow. You’ll think you will, because you will be being offered opportunities all the time, but what you won’t know is that those opportunities have been offered to everyone around the market.”

CapGen generally recommends its clients access private equity through funds, although they do also advise on direct investments, and this is something more investors are expressing an interest in, either individually or by joining up with others in so-called ‘club deals’.

Indeed the very thing that qualifies UHNWIs for private equity, namely their high levels of wealth, often gained from entrepreneurial activities, tends to push them towards a direct approach. “We are seeing an overwhelming interest in moving out of funds and doing a combination of direct deals, club deals, co-investments and so on. People are almost obsessively looking at ways to do this,” says Ms Thorne.

However she urges caution, claiming club deals can end up being extremely complicated and lead to clients overpaying for assets. “Certainly there are families who have made a real success of this, but that really is because they have almost become their own private equity house. They have got the deal flow because they have been doing it for 10 years or more. Trying to catch onto the coat-tails of this as it swoops past is very difficult.”

Gavin Rankin, Emea head of managed investments at Citi Private Bank, which has been offering private equity funds for over a decade, reports client appetite for these products is now strong, having suffered a dip through 2008 and the aftermath of the credit crunch.

However the type of products being distributed has changed. “Private equity tends to go in cycles in terms of what clients are looking for. Up to 2007-2008 there were a number of very big buyout funds that were raised, using large amounts of leverage. On the whole they were 10-year funds with five-year investment periods.”

In 2007-2008 a lot of that leverage disappeared, and Citi reports very little interest today from clients in leveraged buyouts or higher levels of leverage within private equity strategies. “What we are seeing today tends to be more credit focused or more yield focused, while a big theme that clients have been playing this year has been providing capital to banks, as they disgorge their balance sheets and get rid of non-performing loans or sell down their positions because of regulatory pressures,” says Mr Rankin. “A lot of private equity funds have been set up to take advantage of that.”

In this move away from high levels of leverage and operational type strategies towards cashflow and credit strategies, the lifespan of these investments has come down. Whereas before the vehicles would have had a 10-year cycle, five-year vehicles with a two-year investment period and then a two or three-year return of capital are becoming much more common and so are the funds that are attracting clients, he explains.

Marina Stoop, alternative investments analyst at Credit Suisse, notes increasing exposures to private equity, but explains it is coming from those already invested in the asset class as they are the ones with the capability to invest.

The Swiss bank offers a fund of funds approach to clients with a smaller asset base, although this does bring multiple layers of fees. Private equity funds are suggested to clients with more to invest, while direct investments are only suitable for very large, very experienced clients.

Ms Stoop also points to listed private equity, which offers the advantage of small minimum investments and higher levels of liquidity. “Recently, this was one of our favoured investment themes as it traded at substantial discounts to net asset value. However, the asset class has rallied and discounts have narrowed drastically in the process. At this point, we are neutral on listed private equity, but nevertheless, it can be a valuable addition to a portfolio.”

Hybrid structure

David Barbour, co-head of FF&P Private Equity (FF&PPE), at multi family office Fleming Family & Partners, agrees that there has been an enormous amount of talk among family offices and HNWIs about club deals, but says many have run into trouble when trying to put this into practice. “You have to be pretty active, with a lot of manpower. Some people are quite good at it, but the majority remain frustrated. They can’t find access to the deals and they don’t know how to execute them and then manage them.”

To recognise this desire for greater involvement in private equity, his firm launched its FF&P Investor 3 LP fund in 2011, after pre-marketing in 2009 and 2010.

“We went to single family offices and individuals and asked them what they were looking for, and they said ‘we want more visibility, to be able to meet the companies and to have more discretion over what we do.’ I think most of them want total discretion, but they understand why this model is quite difficult to run from a practical standpoint.”

The result was a hybrid structure into which clients must make a minimum commitment of  £250,000- £500,000 (€293,000-€586,000). FF&PPE has discretion over the investments and negotiates transactions with the resulting pot, focusing on British-based companies ideally with potential for overseas growth.

“But with every transaction we will offer investors the chance to look at that deal and put some more in if they wish,” explains Mr Barbour. “So over time they can bespoke part of their portfolio.”  

A world of opportunity

Private equity opens up a huge universe of companies in both developed and emerging economies, and while most managers take a bottom-up approach, some see opportunities in specific regions.

European venture capital is an underfunded opportunity, believes Simon Jamieson, investment manager at Fleming Family & Partners, and often overlooked by US investors. “There is a very big technology base in Europe, and there are far fewer venture capital managers than in the US, so it is a less competitive environment.”

He highlights the UK, Germany and to a lesser extent France, as markets worth exploring.

The other area favoured by Mr Jamieson is Japan, which he believes to be a market just beginning to focus more on shareholders and containing asset rich businesses. “The trick there is actually getting control of a business, and finding a manager who can make the deals. There are a lot of managers that go out there and end up doing so few deals.”

Marina Stoop at Credit Suisse sees potential in emerging markets. With slowing growth and higher valuations in the Bric economies, the focus is shifting to less explored hunting grounds.

“Some of the largest recent emerging market deals took place in countries such as Vietnam, Kenya and Malaysia. Turkey, Mexico and Africa have gained popularity and are now ranking among the top destinations in terms of attractiveness for private equity investments in emerging markets.”

Emerging Asian countries will likely remain top destinations, says Ms Stoop. “Overall, we see emerging markets becoming more and more an integrated part in investors’ portfolios. Yet risks are higher compared to developed markets and include deficient governance practices, regulatory risks and political risks.”