Why private equity?

The effect of adding private equity to a portfolio depends - as always - on the portfolio itself. However, a Pantheon study from 2015* suggests that adding 20% private equity to an equity portfolio can release 3.16% of the annualised excess return. Looking at an investment horizon of 10 to 20 years, this has a significant impact on wealth accumulation. The reasons for this include the following:

Access to unlisted companies
‍The number of companies available for investment on public markets is limited and each traded company is carefully scrutinised. Although public markets can never be truly "efficient", by the time a company goes public, its value will likely already be recognised, causing the price to skyrocket at that point. Private equity funds have access to the private market and therefore to a larger pool of unknown opportunities that are not subject to rigorous scrutiny. They have the resources to scrutinise these companies and identify which ones are suitable for investment.

Leverage effect
Private equity investments are often financed with debt. This practice allows the fund to deploy a smaller amount of cash, while at the same time allowing profits to be magnified in the event of a sale. Of course, the opposite is also true: if the investment fails, there is a significant risk of loss.

Value-enhancing measures
‍Since the goal of private equity investments is to sell the stake in the company, there is a strong motivation to create value. Most modern private equity firms have clear value creation methodologies and often dedicated value creation teams within the organisation. Value creation initiatives can include reorganisations, cost reductions, technological improvements or the introduction of ESG frameworks, all of which are thoroughly planned before an investment is made.
‍
‍

Modern portfolio theory states that business and financial risk should be reduced as much as possible through diversification, which is best achieved by selecting assets with low correlation to each other.

Private equity can contribute to the diversification of a portfolio by minimising both public market risk and economic risk. By including private equity, the return can be increased disproportionately to the increase in risk within a portfolio. Nevertheless, there is still an increased risk within the private equity asset class.
‍

Compared to traditional equity funds, private equity funds benefit from structural advantages throughout the entire investment process.
‍
Purchase
Before making a purchase, private equity funds can analyse potential investments in detail. They use experts with relevant (industry) experience with whom they develop a detailed concept for the investment (the so-called investment thesis).

Increase in value
‍Because private equity funds control their portfolio companies, they can consistently implement their investment thesis after the purchase. Typical measures to increase value range from optimising purchasing and production to strategic acquisitions, geographical expansion and changes to management incentive structures.

Sale
Thanks to their long-term perspective, private equity funds usually have the flexibility to determine the best time to sell a portfolio company. Depending on the situation, an exit can take the form of an IPO or a sale to another company or another private equity fund.

‍

A secondary private equity fund is an investment fund that invests in existing private equity investments that are sold by other investors. This type of investment fund is a popular choice for investors looking to invest in private equity, as it gives them the opportunity to invest in established companies that already have a degree of success and stability. Other advantages:

Attractive risk/return ratio
‍Secondary funds offer above-average returns compared to the equity market, while they have historically had the lowest default risk in the private equity segment.

Shorter terms and faster portfolio development
‍The portfolio companies of secondary funds are generally more advanced, which enables faster generation of exit proceeds. As a result, capital formation is significantly lower compared to other private equity strategies.

Attractive entry-level prices
‍A well-managed secondary private equity fund can achieve above-average returns compared to other private equity investments, as the investment strategy is geared towards identifying undervalued but high-growth companies and investing in them.

‍

Just as the characteristics of private equity can lead to the benefits of higher returns and greater diversification, there are also certain factors that need to be considered before deciding whether an investment is personally the right choice.

High minimum amounts
‍With traditional private equity investments, the high minimum amounts required for an investment were an obstacle for most private individuals.
‍
Low liquidity and delayed cash flows
‍The lock-up period of a private equity fund makes private equity an illiquid investment with a long-term horizon.

Risk of loss
Private equity investments carry a high degree of risk and may result in a partial or total loss of capital. Alternative investments are inherently complex, speculative investment vehicles and are only suitable for investors who have sufficient knowledge and experience to understand the risks involved.

Administrative fees
When assessing a fund, you should not only look at the gross return. You must consider the net performance - after deduction of fees - as this is the return you would actually have received on an investment.