This was written for (and first published by) CFA Institute.
Private equity’s demise has been over-reported.
That’s according to me and to Professor Claudia Zeisberger, founder of INSEAD’s Global Private Equity Initiative.
At the 69th CFA Institute Annual Conference,
Zeisberger demonstrated that private equity is very much alive, backing
up her assertion with reams of data. And personally, I’m tired of
hearing about the rumored death of something immortal.
Critics of private equity are not hard to find, and if you listen to them long enough, you’ll hear all kinds of stories that make your stomach turn. No doubt, there have been bad actors abusing the label of “private equity investment.”
But private equity is a governance structure, not a business model or industry. As Zeisberger defines it, the format encompasses activities that go by many names — venture capital, growth equity, leveraged buyouts — the list goes on a while, depending on how retro you’d like to get with your jargon.
Despite the various challenges faced by each form of private equity investment, private companies need money now and will need it in the future. And on the other side of the equation, there can be attractive incentives for supplying capital. Ted Eliopoulos, the Chief Investment Officer of CalPERS, summed it up in a 2015 investment committee meeting: “Currently, private equity is the only asset class in our portfolio that is expected to exceed our seven and a half percent target rate of return on a net basis.”
Here are a couple of reasons why there are solid opportunities within the broad category of private equity:
- Accessing the right opportunities. Investors in developed markets are used to allocating capital through liquid, well diversified public markets. In China, India, and Japan, the top ten firms represented 18%, 27%, and 17% of the country’s total market capitalization. In Nigeria, Peru, and Columbia, the top ten firms represent 72%, 72%, and 71% of market capitalization. To access the most exciting components of a country’s economic story, an investor will need to go private.
- Repeatable returns. Alternatives are always Rorschach Tests to some degree, and critics will suggest that private equity returns are only repeatable when capital markets provide a source of cheap leverage. But you can’t get leverage without some kind of return stream, and there is evidence that private managers add value. Citing a study on value creation from the Center for Entrepreneurial and Financial Studies and Capital Dynamics, Zeisberger noted that operational value creation accounts for almost three quarters of unlevered returns.
- Idiosyncrasies. It can be hard to analyze investments from both a top-down and bottom-up perspective, especially when considering a massive asset class that spans the earliest to latest stages of a company’s life cycle. But remember: most private equity firms are composed of curious, hardworking people trying to do things differently from their competition. Some will succeed.
It’s not all sunshine and carried interest from here on out. The same set of concerns that apply elsewhere in investing — slowing growth, pricey assets, and intensifying competition — accompany private equity. Zeisberger noted that 96% of investors surveyed by Coller Capital saw high asset prices as a headwind for private equity prices in the coming three to five years.
Private equity firms can add value to the companies they invest in and engage with, but it won’t be easy or automatic. Despite those hurdles, 88% of investors surveyed by Prequin at the start of 2016 expected to commit the same amount of capital or more to private equity this year as they had in the previous year.
Overall, the death of private equity has more in common with the long-rumored death of Abe Vigoda than an actual mortality event.If you liked this post, you should subscribe to my newsletter.