Use private equity to enhance your risk/return profile.
Private equity has become an attractive asset class for private investors. Private equity funds allow you to invest with low capital in attractive companies without the stock market. Read how investments in private equity can boost your portfolio, and what investors should keep in mind.
The market for private equity is growing
An IPO is considered the ultimate achievement for companies and shareholders alike. Nonetheless, more and more companies are deciding to refrain from an IPO or even withdraw from the stock market ("delisting"). In fact, publicly traded companies comprise just a small part of the Swiss economy. Even more surprising: Many investors do not put their money into the private market.
However, investments in this asset class are on the rise in Switzerland too. According to research company Preqin, private equity companies took in USD 14.4 billion in Switzerland in 2017, nearly twice the amount from 2008. Looking across the pond, we can see that private equity is definitely a worthwhile method of portfolio diversification. Company foundations such as those from Harvard, Stanford, and Yale have large investments in private equity, which gives them long-term average rates of return between 10 and 13 percent annually.
Investments in private equity offer investors added value
Investing in private equity is attractive not just for institutional investors but for private investors as well. After all, investments in private equity will diversify the portfolio thereby improving the risk/return ratio. When we look at the primary characteristics of private equity, it becomes evident how this asset class differs from publicly listed equity investments, and what added value it provides with regard to portfolio diversification and the risk/return profile:
- Potential long-term added value: The long-term returns on private equity are often higher than those of publicly listed securities. The additional return in U.S. dollars in the last ten years was between 4 and 7 percent annually.
- Active influence: Private equity managers can actively influence the portfolio companies and contribute their specialist expertise and networks.
- Illiquidity premium: Private equity managers hold investments in portfolio companies over the course of several years and help them implement strategic initiatives.
- Less volatility: Rather than being linked to short-term fluctuations on the market, the valuation of a private equity investment is driven by the operational progress of portfolio companies.
- Expanded investment universe: The majority of all companies are not listed on the stock exchange. Innovative companies that develop disruptive technologies in particular are often in private hands.
Private equity poses risks too
Nonetheless, private equity investments also have their own challenges for investors. Investors should understand these risks if they wish to invest in private equity:
- Financial risks: Investments in private equity funds generally involve a significant degree of financial and/or business risk. Companies or funds may be highly leveraged and therefore may be more sensitive to financial developments or economic factors.
- Illiquidity: An investor should have low liquidity concerns, since there will not be an established secondary market. Investors have to be prepared to keep the investment until maturity and wind-down of the underlying private equity fund. Investments are usually not tradable, or are of limited transferability between investors
- Long-term investment horizon: The time horizon for private equity investments can be ten years or more . It can take a long time until a private company becomes established. Therefore, private equity investments usually need more time until they generate a profit. The first dividends are generally not paid to investors until some years have passed.
Private equity funds are currently attractive for investors
For a long time, private equity was reserved for larger institutional investors, as it required an initial investment of many millions of francs. However, in the meantime private equity solutions have entered the market that pool the capital of multiple investors to invest in single funds or a portfolio of multiple funds. This makes the minimum investment significantly lower. Although the time horizon can be ten or more years, generally speaking the first dividends are paid to investors using the profits generated after just a few years. This allows private investors to benefit from private equity too. However, we advise against placing more than five percent of your total portfolio in private equity investments.