Is private equity (PE) the key missing part of adviser portfolios?
Endowments, the Future Fund (FF) et al, have heralded their high allocation to PE amid claims to better outcomes than those labouring in listed equity markets. This is not the first time the issue has been raised, the Future Fund is noting its allocation and likely increase. For those willing to interpret a fund structure that may have nothing to do with individual portfolios, it is worth a considered look at the various funds the FF manages and their very different allocations.
The comparison is unfair. PE is meant to hold companies in their formative stages often with high and variable cash outflows, or those that badly need a restructure. They can afford to have terrible short term profit results, don’t have to pay regular dividends and can ignore a large amount of the stodgy management issues that dog listed companies. Most importantly they can leverage, and re-leverage if there is a payout into the PE fund, well beyond what would be acceptable in listed land. This is a key component of their returns and stated on a discretionary basis.
Tracking performance of PE is all too hard. There is a mix of too much money chasing deals, J curves, fees, capital calls and the widely held view that returns come from a few winners with a tail of also-rans and downright losers.
Yet there is a large degree of logic start-ups should be in PE rather than list too early. Managing cash flow, be it internally generated or from a sponsor to build a business over the medium term is much more sensible than raising equity capital in listed markets. The listed entity pays usuary investment banking fees, spends an inordinate time on a roadshow and then is held accountable to a lengthy prospectus.
The PE company should be able to receive funds at no discount to the valuation, there is no need for roadshows and fees while there is oversight from a dedicated team intent on getting a big return from its capital.
Logic suggests that many of these start-ups don’t make the grade. Even if they do, often the valuations ascribed to sequential raisings are off the mark, We Work a notable example. Big gains are matched by dreadful losses. The net result may turn out fine, yet the risks are high as the small handful of good decisions are easily outmatched by the raft of others.
The comparison is arguably with high conviction funds with 20 or less holdings and low turnover. It is likely many PE strategies have not sniffed the tail of some of these, be it Hyperion locally or Baillie Gifford globally.
In many ways the battle to compare listed to private investments has limited relevance. They are very different structures and should be accountable within their asset class. Few are comparing the returns from investment grade rated credit securities to private credit as they are very different in risk and structure.
Local access to most PE is woefully limited outside of the institutional market. Venture Capital is better option albeit with associated risk. Over-obsessing on missing out is fruitless. For many investors the illiquidity would be frightening and the decision on which strategy to support is far from easy. Then the comparison to FF and others is not relevant.
Investors should be resilient to unreasonable comparisons and stick to what they can control.