Investment Strategy

Forget Stock Market Volatility! Choose Private Equity Investments

The stock market of today is transpiring with unprecedented volatility.

Daily swings in the major indexes of 3% or more have become the norm. To put that into perspective, the S&P 500 averages yearly returns of roughly 10%, and now you can see those types of swings in a week. So what is an investor to do who doesn’t have the stomach for all the market turbulence?

One option is to have a longer investment horizon and look at utilizing a private equity vehicle. You would not be alone. With the bellwether S&P 500 and U.S. aggregate bond indexes down 17% and 8%, respectively this year, money is flowing from mutual funds at a torrid pace.

‘Private-markets funds have been enjoying inflows amid the turmoil in public markets,” said Anastasia Amoroso, chief investment strategist at iCapital Network Inc., a financial-services company that gives high-net-worth investors access to private equity funds. Assets serviced by iCapital have risen by about 16% in the first four months of 2022, to $125 billion.

Private equity investment has typically been the domain of institutional investors, with pension funds and university endowments, among others, leading the way. As noted, individual investors are beginning to catch on. Similar to hedge funds, to invest in a private equity vehicle, one must be an accredited investor, with $200,000 in annual income or $1 million in liquid net worth.

This is an untapped market for the private equity community, with roughly only 1% to 2% of the $80 trillion individual investor market being allocated to the space, according to PitchBook Data.

Let’s take a look at options available to accredited investors first. One key distinction to consider before investing is that private equity valuations are not influenced by the larger market.

Whereas publicly traded companies must adhere to strict accounting practices set in place by the Securities and Exchange Commission, private companies are allowed more flexibility. This opaqueness is at the crux of the risk vs return trade-off.

The financial statements of a private company are just that, private and not made available to the public. The upside is that historically, especially in down equity markets, private companies have outperformed the broad indexes.

According to the Bain & Co. report, over the past 30 years, U.S. buyouts have generated an average net return of 13.1%, compared with the 8.1% return of the public markets.

The best place to start the investment process is by looking at which private equity firm you want to do business with. They each will have their own areas of expertise, fundraising schedules, investment minimums, etc.

The following is a list compiled by Private Equity International, of the 10 largest private equity firms in the world. 

  1. Blackstone
  2. KKR
  3. CVC Capital Partners
  4. The Carlyle Group
  5. Thoma Bravo
  6. EQT
  7. Vista Equity Partners
  8. TPG
  9. Warburg Pincus
  10. Neuberger Berman Private Markets

If you want to diversify into private equity and you are not an accredited investor, never fear, for there are, of course, private equity exchange-traded funds (ETFs). Private equity ETFs offer exposure to publicly-listed private equity companies. The following are a handful of the most popular private equity ETFs.

As with any ETF, you want to be sure to do your research, specifically checking out past performance and assets under management to help ensure liquidity. The most prevalent type of fund is the leveraged buyout (LBO).

A buyout is when a private equity firm buys a target company with the hope of selling it later at a profit. That company can be public or private, though if it’s public, it will be taken private through the purchase. The concept is similar to flipping a house in real estate.

The private equity firm uses your capital and, often times a loan backed by the company’s assets to purchase the target. The firm uses its expertise to either make improvements to its operations or management, or to help the company grow revenues and profits. Either way, just like in real estate, the goal is to exit or sell the target company for a profit a few years down the line. 

The traditional portfolio allocation of 60/40, stocks to bonds, is always questioned in times of volatility. Bonds in the past have been the safe haven when the ship starts to rock. However, the current climate extends the risk and volatility to the bond market, perhaps making private equity a beneficiary of this change.

According to Apollo Global Management CEO Marc Rowan, “I could see a day in the not too distant future when a client’s portfolio is not 10% or 15% alternatives but is 50% alternatives.” The important thing to remember and consider is your risk tolerance.

This will depend upon a number of factors, including the size of your portfolio, your age, and any individual biases that you have. I’m guessing the average wealth manager today is not on the same page with Apollo’s Rowan and advising their clients’ to have half of their portfolio in alternative investments.

One would think this would be a tough sell anyway. I would think that while this sector is more of a risk-on asset class, investors should still look to place somewhere around 5% to 10% of their portfolio here. 

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