The public capital markets aren’t what they used to be. Many young companies are staying private for longer time periods rather than rushing to do an initial public offering, and private capital fundraising has seen positive compound annual growth rates this decade at a time when the amount of public capital raised has exhibited negative growth rates.
Investors looking for alternative sources of returns can turn to the private equity and private credit markets, but they and their financial advisors need to understand the pros and cons of these types of investments.
“More advisors and their clients are considering the private capital markets for the first time, and we’ve seen an increase this year,” said Nick Veronis, co-founder and managing partner of research and due diligence at iCapital Network, whose platform for alternative investments includes private equity and hedge funds. He spoke during a panel discussion at this week’s Inside Alternatives & Asset Allocation conference hosted by Financial Advisor and Private Wealth magazines in Philadelphia.
According to Veronis, private equity has had a long run where it has outperformed “virtually all other asset classes” to the tune of 250 to 500-plus basis points. “If you’re fortunate enough to invest in top-quartile managers, often due to the illiquidity premium you’ll be in the 600 to 800-plus basis points range over the public markets,” he said, adding that this type of outperformance has been fairly consistent over various time periods during the past 15 years or so.
At the beginning of this century, Veronis said, private equity firms had total assets under management of less than $1 trillion. Today, that number is at roughly $5.8 trillion across a host of assets ranging from natural resources and infrastructure to credit and real estate.
He noted that so-called middle-market companies—those with annual revenue ranging from $10 million to $1 billion—are where private equity firms spend the vast majority of their time sourcing opportunities.
Private equity can make sense for certain investors. Traditionally, it has been the domain of institutional investors and very wealthy individuals who can pony up investment minimums in the seven- to eight-digit range. Some private equity firms offer investment vehicles enabling accredited investors to access this space for $250,000. Private market investments typically have very limited liquidity, and are designed for long holding periods.
“A conversation to have with clients is what kind of exposure do they want to have to the private markets,” said Brendan Finn, director of strategic relationships at Artivest, a digital platform for alternative funds. “Do they want to diversity their equity exposure and access the illiquidity premium? Or do they want to diversify their fixed-income exposure, and for that you can talk about private credit. This is a seven- to 10-year commitment, so these are sticky assets for you and your clients, and you can take out some of the market volatility.”
John Coyne, chairman of wealth management firm Spouting Rock Asset Management, identified three basic ways to access private equity. One is through new funds being created; another is with direct investments where investors buy in with a single transaction; and the third route is via the secondary market. The secondary market doesn’t entail buying other direct businesses already in the private or public markets; rather, it involves buying limited partnership interests in the funds that facilitate private equity such as those from the likes of KKR & Co., Apollo Global Management and Blackstone.
The secondary market is the sweet spot for Joel Kress, chief operating officer at Pomona Investment Fund, a private equity firm and wholly owned subsidiary of Voya Financial.
He said his firm’s private equity funds are registered closed-end funds with either quarterly or monthly inflows and quarterly liquidity on a limited basis. They issue 1099 tax forms rather than K-1s, and all of the capital is subscribed from day one (versus having to fund capital calls for at least a minimum of five years for institutional-level private equity investments).
“The upside of these vehicles is you don’t have to manage the capital call structure, but the downside is you have to look at all of our vehicles because we’re going to have to manage cash on our end rather than on your end,” Kress said. “That’s one of the factors you need to consider.”
He noted that Pomona’s secondary private equity funds are designed to be steady-as-she-goes products. “We’re a singles and doubles player,” he explained. “But in every one of our funds going back to every quarter since 1994 we’ve had distributions. So there is liquidity in this space because when you have a broad-based diversified portfolio there’s always going to be some level of activity going on.”