Should a well-balanced portfolio include stakes in interesting private firms? (These include upstart biotech ventures with promising inventions they’re taking to market, as well as companies with a sharp bead on new ways of distributing green energy to consumers, for example)
The answer is a qualified yes.
Private equity vehicles—everything from venture capital to mezzanine financing and buy-outs—are best suited to very affluent investors with loads of patience and the wherewithal to stick out investment cycles that can easily exceed a decade, say advisors who specialize in working with high-net-worth investors. Capital can be tied up for years, but the trade-off for that illiquidity is the potential for attractive rates of return.
“I’ve never recommended private equity investing for anyone who doesn’t have significant cash and a very long-term time horizon,” says Susan Latremoille, a vice president and wealth advisor at Richardson GMP Ltd., who points out the vast majority of active businesses are not publicly traded. “But the returns should be higher than what you can get in the marketplace.”
In her view, a qualified investor should have about 5% to 10% of their assets in private equity, but that benchmark is a function of the individual’s status; those who operate an active business already have assets tied up in private equity—their own—and should probably be looking to diversify their holdings through other asset classes.
Private equity tends to be tied to the economic cycle, with more activity—especially buy-outs—occurring early in a recovery phase. Deal volume jumped during the early 2000s as major private equity firms like KKR, Blackstone and Bain Capital, executed multi-billion dollar buy-outs of firms such as Shoppers Drug Mart and Yellow Pages.
Like most sectors, private equity struggled after the 2008 credit crunch, but analysts are seeing signs of a return. “We’re increasing our allocation to private equity,” Guy Dietrich, the head of UBS AG’s (UBS) New York private wealth management office, told Dow Jones recently. “It’s a tactical decision.” Other analysts are recommending private equity funds lend to small and medium sized businesses that may have difficulty obtaining bank credit.
But wealth advisors aren’t uniformly sold right now.
Marg Franklin, president of Kinsale Private Wealth, says that given the current investment climate, private equity remains too illiquid, with excessive management fees. “Those markets aren’t particularly attractive to us right now.”
Private wealth advisors also warn the quality of the PE fund managers is extremely important. The top-notch firms, like Boston’s Bain Capital, are very active investors, and will often insist on not only board seats, but may be highly involved with a target firm’s operational and restructuring activities.
As Tom McCullough, president and chief investment officer at Northwood Family Office, notes the difference in returns between a highly regarded mutual fund manager and a less distinguished one tends not to be large, but there’s a huge difference between top-flight PE managers and poor ones.
Some wealth advisors have exclusive distribution relationships with private equity firms—Richardson GMP uses Kensington Capital Partners, a fund of funds—whereas others go with established players like Northleaf Capital (formerly TD Bank’s private equity group). Gerry Schwartz’s Onex Corp., though publicly traded, offers private equity funds through its Onex Partners division.
This article was originally published on capitalmagazine.ca.