Private equity as an asset class had an outstanding run from 1998 to 2006. More recently, with the bear market and the forced unwinding of highly leveraged positions, many of the big private equity firms such as Blackstone Group and Fortress and others have taken a bit of a hit.
But the reports of private equity’s demise, to paraphrase Mark Twain, are exaggerated. In an MSNBC online article written by Kristin Graham of the Motley Fool, she argues that ordinary investors could learn a thing or two about investment success from studying private equity.
For instance, unlike public companies, PE firms don’t have to report short-term results, so they can stay better focused on long-term results. A PE manager knows his exit strategy upfront, so he’s ready to act swiftly when the time comes. And PE executives’ compensation (as well as a sizeable chunk of their own holdings) are usually tied to the performance of the business.
Graham suggests that investors look for similar qualities when investing in the stocks of public companies. Such as firms with outstanding corporate governance structures like Walt Disney. Or firms with a clear long-term perspective, such as Warren Buffet’s Berkshire Hathaway. And companies that tie executive compensation clearly to performance. Sergey Brin and Larry Page of Google, for instance, take home just $1 in salary with the rest tied to performance-based incentives.
Many private equity firms have done an outstanding job at extracting value from the companies they manage. In fact, as we’ve discussed in this blog before, PE firms have a better track record at managing their companies than family-owned and government-operated firms. Graham suggests that by looking for public firms that operate in a similar way, you can get a better value out of your equity investments.
The global economic crisis has churned up the private equity world, not only for PE firms but also for the primary investors in the asset class. A recent Wall Street Journal article looked at how a ranking of the most influential European private equity investors reveals a seismic shift in power, now that private equity funds are no longer oversubscribed and investors can be pickier about their investments.
The industry in general still has broad appeal, given its ability to deliver above-average annual returns. Some major investors have actually boosted their allocations to it. However, the credit crunch and fall in asset values means that the rate at which private equity firms have been able to exit their portfolio investments has slumped since its peak in 2006-2007.
“The losses experienced in the industry have not been as extreme as those suffered in other asset classes,” said Vincent Gombault, managing director of funds of funds at Axa Private Equity. “Of course, given the conditions in the market, many private equity companies are waiting for the right time to put their money to work. While some investors are impatient, many understand and support the need to wait for the most apposite time to invest.”
Private equity may be better able to adapt to today’s tumultuous environment than other asset classes, due to the long-term nature of private equity investments and the influence that private equity managers have over entry and exit decisions. That’s the view of Peter Pfister, recently named managing director of private equity at Deutsche Bank’s Asia-Pacific Private Wealth Management group.
Pfister told AsiaBusiness that private equity is one of the few asset classes that can actually thrive despite the credit illiquidity that has plagued other sectors. For one thing, PE firms do not face the same risks of investor redemptions as hedge funds. This means they do not have to unload assets in a fire sale to meet those redemption calls. This flexibility allows PE managers to stay out of the markets if conditions are unattractive, and concentrate instead on improving the operations and profitability of their existing portfolio companies.
The other silver lining in today’s financial clouds is that private equity investments made during recessionary times have often delivered the best returns, even without leverage. Pfister believes 2009 and 2010 investments will follow this pattern. He specifically cites the areas of distressed, credit-driven and mezzanine investments as offering compelling opportunities this year and next.
