Why I'm in no rush to join the private equity club

Just as private equity is beginning to open up to retail investors, the conditions that underpinned its investment strategies are starting to unravel. Merryn Somerset Webb explains why she's investing elsewhere.

IN the past six weeks I've been given complimentary membership to two "exclusive" clubs. Initially I was flattered. Then I realised I had no reason to feel remotely special. New "private clubs" open every day in central London. It is a hugely competitive market in which only a few establishments can get sufficient buzz going to be able to actually refuse people they deem unsuitable (think Soho House).

The rest have to go out begging people to be members. So, when I stop to think about it, I don't want to be a member of any clubs so nonexclusive that they have to ask me to join rather than waiting for me to beg to be let in. No vetting? No being put up and being seconded? And no fee? It suggests they are having trouble getting paid-up members and if the movers and shakers aren't joining why would I want to?

London's clubland has something to tell us about the private-equity and hedge-fund industries. There has been much moaning in the past few years about how the retail investor cannot get proper access to hedge funds and private equity. Instead of helping the middling well-off get rich, they have long been seen as exclusive clubs that help the rich get richer.

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We might not be hearing these complaints for much longer.

Hedge-fund giant Fortress has already floated, and London-based GLG Partners and New York's multi-strategy hedge fund Och Ziff Capital Management have both announced similar plans. A few weeks ago private-equity giant Blackstone also offered shares to the wider market and Kohlberg Kravis Roberts (KKR) owner of Toys 'R' Us among many, many others is about to do the same.

But is now really a good time for us to take this lot up on their offer to join their club? Maybe not. Look at private-equity companies. We've seen a backlash against their tax status here, and a similar one is under way in America, so clearly the political environment is worsening.

More worryingly, so is the financial environment. The low interest rates and easy credit that underpin their investment strategies are slowly disappearing as the carnage in the US sub-prime market shows. For the first time in many years companies are having trouble raising money in the credit markets last week several firms including steel group Arcelor Mittal and US retailer Dollar General had to drop bond issues.

At the same time lenders are apparently beginning to tighten their standards (no more lending cash willy-nilly with no strings attached). Interest rates are rising as the world's central banks try to keep inflation under control and spreads are still widening in other words, interest rates on money borrowed for risky projects are rising faster than base rates so this is not a situation we can expect to see improving.

Not long now and the maths of private equity will no longer add up (I looked at how these firms use low interest rates to make money in a column a few months ago you can find it here: Profit from private equity's secret recipe).

The likes of KKR may sound good on paper, but I can't see that there is any more point in buying the shares than in patronising an "exclusive" casino club in St James that has opened its doors to one and all.

Neither is offering you anything special any more. If they were they wouldn't be offering it to everyone else too. My guess is that we will soon hear retail investors complaining, not that they weren't able to invest but that they were.

The good news is that there are plenty of other things out there worth buying, regardless of the trouble in the credit markets and the rising volatility across the equity markets. We should be holding big oil (Shell seems to get cheaper and cheaper) and hanging on to our commodity investments. Beyond that, I've mentioned quite a few investment trusts and investment companies in this column recently (and I'm looking at a few more for discussion over the summer) but a note from broker Killik and Co has reminded me of the Herald Investment Trust, which invests in small listed technology companies around the world.

The tech sector has been shunned by everyone who lost money in 2000 for far too long. The Herald trust's portfolio trades on an average price/earn-ings ratio of 14.4 times, yet for the 2007 financial year it has projected earnings growth of 58%. This means its portfolio is trading on a ludicrously low price/ earnings growth factor of under 0.3 times (you divide the p/e ratio by the projected growth rate, and anything under 1 is generally considered cheap). Better still, the trust is trading at a 13% discount to its net asset value.

The fund is cheap and so are its holdings. I'm not sure you can say that about many of the big private-equity funds or indeed the hedge funds coming to market at the moment.

First published in the Sunday Times 8/7/07