What to look for in private equity

By Andrew McAuley

After a period of good returns from equities and bonds and with the official cash rate at 1.0 per cent, many investors are looking for ways to reduce risk and diversify their portfolios. Adding alternative investments such as private equity is one way to do this.

Alternative investments are any asset other than stocks, bonds, and cash, and which can act as building blocks to diversify portfolios. Hedge funds, commodities and real estate are all considered part of the alternative investments universe, as is private equity.

Investors should aim to build a self-financing private equity portfolio that has sufficient distributions to cover future capital calls.

Private equity funds take equity stakes in companies or assets that are not publicly traded and work closely with the management teams to increase their value to be able to sell again at a higher price. Thus, by their nature they are less correlated with equity and bond markets as value realisation depends on restructuring and effective management and not investment market movements.

Investors, mostly institutional and high-net-worth individuals, can put their money to work in a different way, as an alternative to buying stocks in companies that are listed on public markets.
The investments can be used to finance startups (venture capital), inject working capital into a growing company (growth capital), acquire a mature company for growth or reshaping (buy-out), or purchase assets or loans that are in distress and need refinancing (special situations/distressed debt).

Potential for returns

Private equity tends to outperform public markets. This is driven by the fact that these assets are privately held, allowing managers more time and control to implement value-creation strategies.
An important factor to investors in creating excess return is the selection of best-in-class, hard-to-access fund managers. This, however, requires a disciplined due diligence process and access to a broad network of high-performing funds. Going one step further, the various strategies under private equity can each present interesting opportunities as well as different risk-reward profiles.

Read more in:  https://www.afr.com/personal-finance/budgeting/what-to-look-for-in-private-equity-20190711-p526ab