If you look at the public market, you will find that it is not as popular as it used to be. Due to the decrease in the popularity of public markets, many investors are going for private equity investments instead.
The COVID-19 outbreak made a huge impact on the economy. Due to the massive slowdown, private equity firms need to come up with new ideas. At the same time, PE industries also need to overcome some major barriers in its path. All this means that investors need to be on their toes while evaluating private funds and dealing with the fund managers.
We’ve read many articles like osakesijoittaminen and spoken to many financial experts. Here are a few things that an investor needs to think about at the time of investing.
Is the Fee Appropriate?
Investors need to understand that they need to pay a management fee while investing in a private equity fund. The annual fee is around 2 percent of the total sum invested and is slightly higher than passive public funds. The reason behind this hike in fee is the role of PE managers.
Another significant difference between public funds and private equity is the carried interest of later. Private equity has an interest of around 20 percent of that fund’s profit.
The Duration of the Investment and Liquidity Tolerance
In active management, true private equity is utterly important, and thus a good PE manager needs to ensure that:
- They shortlist the companies that will show growth in the future.
- Understand the direction the industry is taking.
- Use strategies that help in reducing unnecessary expenditures.
Time plays a critical role in these activities. If a manager wants to get the best deals and exit the investment with a profit, then he or she needs to be patient.
Private equity consists of various strategies in its illiquid design. Some of the popular ones are venture capital, buyouts, infrastructure, real estate, and private credit.
In case of a buyout fund, which lasts for about ten years, a manager gets ample opportunity to create a significant profit. On the other hand, credit-based strategies last for three to five years. These offer a current income component to reduce their illiquidity.
People investing in a PE commit to investing a given sum, a capital commitment. In contrast to the public market, the capital in private equity is not invested immediately. Here the fund manager analyses various companies for a stake. At the end of the fund lifecycle, i.e., when the fund is sold or recapitalized, the investors are paid back handsomely.
The Allocation Process
Most investors believe that allocations are done by asset class. They look at public equity & private equity, and public debt & private debt. There is nothing wrong with this approach, but a better approach would be to consider the private drawdown strategies as a part of equity vs credit vs real asset exposure.
Researching and Evaluating Private Equity Options
When comparing private equity with public investments, one will notice that private equity relies heavily on the manager’s skills. So, you need to be careful while selecting a manager. To do so, you need to
- Start by comparing fund returns for a manager against other similar-sized funds and strategy for the first investment made in the fund.
- Once you are done with the basics and find a manager that has been performing consistently, you need to look for the factors that helped the manager succeed. If those factors are still relevant, you can proceed forward.
- Once you are satisfied with the way through which the manager created those returns, you need to analyze the sector, Geography, Investment Source, Equity check size, and Lead investment.
Managers need to submit a quarterly returns report to investors. However, estimating the value of illiquid holdings is difficult. Additionally, a manager’s ability is unknown until the investment is sold. These uncertainties mean that the investors need to know how the market is performing. A quarterly report that contains internal rate return, the total value to be paid in capital, distributed to be paid-in capital, and residual value to be paid in capital is important.
An investor should understand the risks and the fact their money would be locked-up for up to 10 years before investing in PEs. If you are okay with these factors, then PEs are a good way to invest your money
Source: Deccan Herald