Kristian Zimmermann, Co-Head Private Equity, MLC Asset Management
Although the history of private equity (PE) is traceable to 1901 with finance titan J P Morgan’s acquisition of the Carnegie Steel Company from Andrew Carnegie and Henry Phipps,
it was only in the 1980s that PE began to gain public attention.
On the back of the economic liberalisation wave sweeping the world, a new generation of US investment firms made headlines including by buying well-established companies listed on share markets like supermarket operator Safeway and tobacco and food products conglomerate R J R Nabisco.
The theatre involving these new generation investment companies and their sometimes-larger-than-life founders spawned best-selling books as well as movies. All this made private equity – which generally involves buying companies that are not listed on share markets – seem almost otherworldly. Like something you had to be in-the-know to be able to access.
But as has time progressed, PE investments have become more mainstream finding their way into the portfolios of large Australian and global superannuation and pension funds, sovereign wealth funds, university endowments, family offices, and high-net-worth individuals.
Meanwhile, retail investors, who until recently have been unable to access PE investments in a meaningful way, are now starting to receive attention from investment managers eager to make this asset class available to a whole new investor segment.
A massive global opportunity set
There are multiple reasons why institutional investors and high-net-worth individuals have taken to private equity, and why it may be of interest to retail investors.
Firstly, there’s the sheer size of the industry and hence a great breadth of investment opportunity.
According to a McKinsey & Company study, total assets under management in the global PE industry hit a whopping US$9.8 trillion in June 2021.1
Adding private equity to the investment mix introduces another source of diversification to portfolios that would otherwise be dominated by share market and traditional bond market investments.
Giving companies time to execute business strategies
A feature of private equity is that it gives managers of PE-owned companies the time and space to implement business plans without constantly having to look over their shoulders, which is what happens in companies listed on share markets.
The quarterly reporting cycle that listed companies are subject to means that executives are constantly under pressure to manage for short-term results. Just one disappointing quarterly result can send a listed company’s share price tumbling.
Contrast that with what happens in private equity where company managers and employees are incentivised to deliver operational and financial improvements over multi-year time scales. ‘Rome wasn’t built in a day’ and private equity recognises this.
Ability to influence company direction
Even the largest shareholders usually only own a small proportion of a listed company’s shares. Again, contrast this with private equity.
In private equity, a handful of investors, usually through a private equity fund, either own companies outright, or assume large ownership stakes in those companies. This provides the ability to genuinely influence companies’ strategic direction and business plans, through board appointments, and management appointments.
It’s also usual for experienced private equity managers to have intimate knowledge of the operational and financial details of investee companies, and their industry eco-systems, and use this knowledge to engage with company management to generate change and drive company performance.
Different PE segments
There is no one size-fits-all in PE investing. There are managers offering PE funds specialising in venture capital to nurture start-up businesses, all the way to managers with funds targeting large, established private-held companies, and sometimes even listed companies (taking them private upon acquisition and then delisting them from a stock exchange).
Venture capital private equity funds generate excitement, after all, who wouldn’t want the chance to get in early on a start-up that may turn out to be the next Google, or Facebook? However, the failure rate of venture capital is notoriously high. For every Facebook and Google, there are countless more start-ups that fall by the wayside.
By contrast, mid-size, more established companies can be attractive to PE investors wanting a kind of Goldilocks investment – companies that have proven themselves by growing to a reasonable size, but still with strong growth potential ahead.
Awareness of PE investment risks
As with any investment, there are risks when including private equity in an investment portfolio.
Key among these is that private equity is a long-term investment. PE funds typically invest in companies over four-to-six-year periods.
A lot can happen over this time frame and investors need to be aware that most private equity funds do not provide the liquidity that is available with publicly listed shares. However, innovative investment structures providing more liquidity to investors are emerging which help make the asset class more accessible.
Options for investing
If you would like to access private equity, please speak to your financial adviser to determine if there is a product in the market that is suitable for you.
1Private markets rally to new heights. McKinsey Global Private Markets Review 2022, McKinsey & Company
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