The industry is in agreement that private equity is an increasingly attractive area due to the number of good companies choosing to remain unquoted, as well as its uncorrelated nature that protects investors from the market's ups and downs.
Accessing it, however, is not as straightforward.
Too many barriers, not enough money
Apart from the general warnings that accompany investing in illiquid assets, wealth managers have to overcome a number of obstacles to enter the asset class.
The most common challenge is the hefty costs of private equity funds, such as Carlyle or KKR, which often factor in underlying performance fees. Another is the high entry minimums required by such funds that can reach six figures for an individual client.
These vehicles are traditionally structured as limited partnerships aimed at institutional and ultra-high net worth investors, says Tilney managing director Jason Hollands.
|Number of private equity deals worldwide (in billion USD)|
'While used by private banks and firms offering family office services, they are not readily accessible to most wealth managers or their clients and many will not have the required knowledge or due diligence capabilities to select them.'
As a result, several wealth managers seek exposure through investment trusts that are significantly cheaper, but have the drawback of being quoted vehicles themselves, thereby leaving investors exposed to market volatility, which, to an extent, defeats the purpose of investing in the asset class as an uncorrelated asset.
Stanhope Capital, which manages £10 billion across 200 clients, is a private office large enough to invest purely through private equity funds.
The one that makes the grade
Chief investment officer Jonathan Bell said the firm usually recommends that clients have 20% of their portfolio in different types of private equity, including private credit and real estate, as they are all structured in a similar way.
‘It is better to invest through the well-known names such as Advent International, Permira and Apollo,’ Bell said.
‘Private companies have the ability to choose their investors, so they go to managers that have already performed well and this makes a big difference.
‘Typically, a fund might have a £5 million investment minimum for an individual client. What we do is put together an access vehicle where we can pool clients together and invest in one pool.’
Bell (pictured below) added: ‘The returns that we get in private equity are above what we can get for similar risk in quoted markets. The complication is that they are illiquid so we warn clients that it will take an average of two to three years to get the money invested and then five years before it starts coming back.
‘We also say: “don’t commit all of your investment in one go”. It can take five years for the client to make their commitments, so it takes about eight years to build up your private equity portfolio.’
On the wealth management side, Brewin Dolphin, with more than £42 billion in assets under management (AUM), has a more structured approach to accessing the asset class than some of its peers.
The firm uses the investment trust option with names like HarbourVest or HgCapital.
Fund analyst Tom Jemmett said: ‘Our key metric is the performance of private equity managers. We look for premium performance versus the peer group and listed markets coupled with the ability to manage risk.’
EQ Investors and Tilney also rely on such strategies.
Following the lower costs
Although EQ is considering accessing private equity through a fund of funds approach using Pantheon International or ISG, head of investment Sophie Kennedy said the firm currently only has exposure to the asset class through vehicles like Scottish Mortgage and Caledonia that allocate 18% and 31% to unquoted stocks respectively and lack the high fees charged by others.
EQ, which has £780 million in assets under management, is looking closely at private equity but wants to find an experienced manager with a conservative approach and no eye-watering charges.
|Value of private equity deals worldwide in 2018 by target country ($bn)|
Tilney also said it does not have a specific private equity allocation in its asset models. However this can fall within allocations to alternatives if a discretionary portfolio manager wants to invest in a private equity investment trust for a client.
‘For some of our ultra-high net worth clients we may invest in private equity limited partnerships and we do make use of venture capital trusts (VCTs) and enterprise investment schemes (EIS), where appropriate, as part of our financial planning,’ Hollands said.
'Over the years a number of trusts have expanded their mandates to allow allocations into private equity, including Foreign & Colonial, RIT Capital Partners and Scottish Mortgage, both for asset diversification purposes, but also to enable them to capture exposure to businesses at often exciting phases of their development where management teams are highly incentivised to generate value.’
A bad time to buy
Elsewhere, Seven Investment Management, with more than £14 billion in AUM, has only a tiny fraction allocated to private equity within managed portfolios, as it considers this to be a bad time to buy into the sector.
Head of portfolio management Haig Bathgate (pictured below) said it is an asset class that has to be bought at the right point in the cycle: in the depths of the recession, not 10 years into a bull market when the price equity ratios are at their poorest.
‘EIS and VCTs offer access to private equity too. But there is a reason that the government offers the generous tax perks - the risks on these embryonic investments can be substantial,’ he said.
‘The key thing we say is to make sure the investment case is strong enough irrespective of the tax breaks, so the tax tail doesn’t wag the dog. It is important to spend time with clients to ensure they understand fully the risks and benefits. But when EISs and VCTs work, they can work well and the clients enjoy the returns in a very tax efficient way.’
Not everybody’s cup of tea
RC Brown, a much smaller player managin some £260 million in assets, is staying clear of the asset class for similar reasons. Other than the high charges, investment manager Alan Beaney is not impressed by its illiquid nature.
'It is by definition a five-year investment and if people get scared you can’t liquidate,’ he said.
‘There are so many and varied investment methodologies. Some will be start-ups others will be projects going on for a number of years. And there is too much money following the same investments.’
He is not ruling out buying private equity investment trusts in future, however.
‘This is effectively like any asset class,’ he said. ‘We are looking for something that’s undervalued but it’s more difficult with private equity. You can’t have an idea of what you’re buying and what potential value it has.’