This Citywire Switzerland article was written by Sébastien Leutwyler, managing partner and CIO at Geneva-based independent asset manager Capitalium Advisors.
Private equity is less and less the private hunting ground of insider and institutional investors and increasingly popular with private investors.
In addition to its attractive prospects for returns, private equity owes this success to its loose correlation to certain risk factors, such as inflation and money in-and-outflows, that underlie conventional market assets, and is contributing to reduce the overall sensitivity to the financial cycle.
These are especially attractive features in portfolio management as they help better control risk metrics and, hence, offer clients more robust allocations during volatile periods on the financial markets.
Most of all, private equity features a direct link to the company’s world and its strategic and operating challenges, requiring investors to look at things from the point of view of the business cycle.
Private equity’s proximity to the real economy is another reason for its success. With its greater impact, private equity is in phase with the growing interest by new generations of clients in taking part in entrepreneurial successes, led by start-ups.
Private equity opportunities make it easier for clients to make portfolio dynamics their own through more concrete and hands-on situations.
So, on paper, private equity has everything going for it. However, in practice, it is true that this asset class carries its own special requirements, which revolve around investment discipline.
The most prominent of these requirements is the duration of investments, which alone are enough to put off some investors.
But, from our point of view, this helps ensure a match between the client’s expectations, his wealth structure, his actual risk appetite, and his true investment horizon.
Another requirement is the comprehensive due diligence of the solutions on offer, as only that will limit this asset class’ main risk, i.e., the experience and know-how of the counterparties with whom one decides to invest. The illiquidity of investments makes it hard to change your mind once you have committed.
It is also necessary to properly define the type of private equity that you want for your portfolio and to establish a clear investment methodology and proper diversification of the four decision-making vectors of:
- Choice of strategies (e.g., LBO or venture capital),
- Choice of vehicles (funds or direct deal),
- Sector and geographical breakdowns; and, something specific to private equity
- Diversification in vintages, i.e., over time.
To meet the requirements of this asset class, we recommend splitting up allocations through a four-stage investment programme:
Step 1: Funds of funds
Funds of funds serve as a foundation for your allocation, allowing you to contain specific risks and to initiate broad, diversified and rapid coverage over an entire vintage.
Step 2: Secondary funds
Secondary funds save time and optimise programme liquidity by shrinking the cycle of capital calls and returns.
Step 3: Niche funds
Niche funds offer an opportunity for targeted exposure to a strategy, a vehicle or a sector, with the goal of better adjusting an asset class’s potential to each client’s special requirements.
Step 4: Club deals
This last phase consists in setting up a series of exclusive deals through one’s network of contacts.
To make your private equity allocation as transparent as possible, we suggest that you isolate it operationally within its own section of your portfolio.
By doing so you create a self-funding mechanism. In other words, in a few years, returns of capital from your first investments should be sufficient to finance cash calls from new investments.
To sum up, private equity offers managers a special opportunity to demonstrate their added value, their research skills, and the abundance of their networks, and to guarantee the aligning of long-term interests that clients are often promised.
For clients, private equity offers an opportunity to invest their wealth meaningfully, as well as an opportunity to begin thinking about their estate, given private equity’s trans-generational and long-term nature. Investing in private equity also means thinking about the next generation!