The benefits of private equity are about to get tested
Private equity has grown ever more popular in recent years. But its touted benefits are set to be tested, says John Stepek.
Private equity – put simply, investing in companies that aren’t publicly listed – has grown in popularity as an asset class over the last few years. Advocates point to the fact that private equity returns are simultaneously at least as attractive but less volatile than stockmarket returns (in other words, investors endure fewer ups and downs). Detractors note that this is purely down to the use of borrowed money, a lack of liquidity, and the absence of “mark-to-market” accounting, not to mention a more recent trend towards certain funds effectively re-selling assets to themselves at favourable terms and prices.
Cutting through the debate, however, one thing is hard to dispute. In an environment in which we’ve gone from frenzied boom to painful bust for “growth” companies, and in which interest rates and inflation are both rising, it’s hard to imagine any realistic scenario where private company valuations haven’t suffered too.
As Mohamed El-Erian put it in the Financial Times last month, it’ll be harder for private equity firms to borrow money to take firms private, and wobbly equity markets also mean that exit valuations “are less certain”. That’s before you even start to consider the pressures the new environment places on the portfolio companies themselves. It’s quite possible that some have been purchased at valuations which they will never be able to justify, regardless of holding period.
MoneyWeek
Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE
Sign up to Money Morning
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
Don’t overcomplicate things
So what does this mean for you as an investor? Firstly, it’s a useful reminder that as private investors we have the luxury of keeping our asset allocation simple. You’re not running a pension fund and thus have no need to justify your existence by buying into overly-complex (and expensive) strategies.
At MoneyWeek, we suggest you think in terms of just five asset classes: bonds, equity, property, cash, and gold. They each have different qualities which make them useful under different economic circumstances. In this context, private equity is part of your equity exposure, and not something you “need” to own as a distinct asset class.
Secondly, it also implies that even if you are tempted to invest in private equity, you might be best to wait it out for now. For example, discounts on private equity investment trusts have expanded this year. But that might simply reflect concerns that the value of underlying portfolios will be written down.
As El-Erian points out, “historically, revaluations have tended to lag behind public markets by a minimum of six to nine months”. So there may well be better opportunities to buy in the future.
SEE ALSO:
Private equity – the new kings of Wall Street
-
Energy, healthcare and utilities: how to tap into AI in the real economyAI promises to add to the productivity and profitability of much of the economy beyond tech. Here’s two themes to tap into AI in the real economy.
-
How Junior ISAs could help with inheritance tax planningLooming inheritance tax changes will limit how much pension wealth can be passed on but more people may be maxing out their loved ones’ JISA allowance instead
-
Halifax: House price slump continues as prices slide for the sixth consecutive monthUK house prices fell again in September as buyers returned, but the slowdown was not as fast as anticipated, latest Halifax data shows. Where are house prices falling the most?
-
Rents hit a record high - but is the opportunity for buy-to-let investors still strong?UK rent prices have hit a record high with the average hitting over £1,200 a month says Rightmove. Are there still opportunities in buy-to-let?
-
Pension savers turn to gold investmentsInvestors are racing to buy gold to protect their pensions from a stock market correction and high inflation, experts say
-
Where to find the best returns from student accommodationStudent accommodation can be a lucrative investment if you know where to look.
-
The world’s best bargain stocksSearching for bargain stocks with Alec Cutler of the Orbis Global Balanced Fund, who tells Andrew Van Sickle which sectors are being overlooked.
-
Revealed: the cheapest cities to own a home in BritainNew research reveals the cheapest cities to own a home, taking account of mortgage payments, utility bills and council tax
-
UK recession: How to protect your portfolioAs the UK recession is confirmed, we look at ways to protect your wealth.
-
Buy-to-let returns fall 59% amid higher mortgage ratesBuy-to-let returns are slumping as the cost of borrowing spirals.
