Understanding private equity – a guide for external asset managers
Private equity funds have increasingly moved into the focus of a broader group of investors looking for returns and investment diversification. Indeed, this asset class has historically produced strong returns. As a result, investment advisors (such as EAMs) are increasingly faced with questions from their clients on whether and how to get access.
Private equity as portfolio diversifer
Private equity (PE) funds invest mainly in privately held, unlisted companies with a view to increasing their value and selling them at a later stage. This means PE fund managers are focused on driving operational improvements within the investment company and have a clear value creation plan. This can be done at different stages of the life cycle (from venture capital, through growth capital, to buyouts). As a result, PE funds have distinct alpha potential while still providing diversification across various dimensions.
Access to opportunities can be difficult, given the private nature of investments and time horizon of value creation, as well as the structure of deal sourcing. Furthermore, investors have to accept a certain illiquidity. A typical PE investment consists of a period when the manager obtains commitments from investors (commitment period); once capacity is reached, the fund closes. The money is then invested over a period of around five years; this is followed by the harvest period (again around five years), when proceeds are returned to investors.
How external asset managers create added value
In a recent survey of the Swiss market by the CAIA Association and Stableton,* the three main challenges when investing in private markets are, firstly, access to good deals (>45% of respondents), second, investment size (>30%) and, third, lack of liquidity (>30%). These challenges are real and relevant. Investment advisors (such as EAMs) with access to a solid PE offering and the ability to map this to their clients' needs and investment requirements enjoy major opportunities in terms of providing value added to their clients and strengthening their long-term collaboration.
In the remainder of this text, we look at how these challenges can be met and at how Credit Suisse can support EAMs in answering client requests on this asset class.
Challenge 1: Access to good deals
Given the active involvement of private equity fund managers in the value creation of their holdings, access to the best managers is key. When looking at the performance of PE managers, we see that the dispersion of results is much higher than with public markets. Therefore, finding the top managers but also getting access to them is a key part of a PE investment process.
Managers usually launch funds on a regular basis (vintages). As a result, strong managers with proven track records in previous funds usually attract more money that they can put to work. Therefore, they tend to restrict access to partners that have invested in the past. Given the long history of Credit Suisse as an investor in private equity, our feeder fund platform has strong relationships to such top-quartile managers. Credit Suisse has over three decades of experience in the PE space. In addition, a due diligence team reviews each deal and manager to ensure that the manager and fund match our requirements. Of the 600-plus opportunities reviewed by the due diligence team, less than 2.5% are approved.
Challenge 2: Investment Size
The illiquidity and risks associated with investments in private equity mean that investors that have a need for liquidity and do not have the appropriate risk tolerance or requisite knowledge should consider listed alternatives that provide some elements of a diversified PE portfolio (evergreen funds that manage a recurring portfolio of investments and liquidity, such as Partners Fund).
Yet even for investors with significant investable cash, the minimum requirements imposed by large private equity funds can be a showstopper. Let's assume the classical portfolio composition with a 5% allocation to private equity: If a fund has a minimum investment of CHF 250,000, the portfolio would need to total at least CHF 5 million in order to allow such an investment. And this does not even take into account the fact that diversification across funds, strategies, and vintages is recommended. One way to mitigate this is to participate in a diversified vintage program that provides access to a number of different funds from one vintage and invest on a rolling basis.
The Credit Suisse Seasons Global offers such an opportunity by providing access to funds from Credit Suisse's broad network of PE partners. As such, it allows the construction of a diversified portfolio within one vintage with only one feeder fund (i.e. bringing down the required commitment). In addition, the Credit Suisse feeder structure allows investors to gain access at a much lower minimum than is usually the case with investing directly with the respective funds. This is possible due to Credit Suisse's scalable administrative processes and capital call management.
Challenge 3: Illiquidity
Illiquidity is a feature of private equity funds, reflecting the underlying investment and return strategy. As such, increasing the liquidity of PE investments always comes at a cost (e.g. watering down returns with holdings in liquid assets) or is subject to other risks (if investing in commingled funds). For investors to reap the illiquidity premium, the downside of low liquidity has to be accepted and planned for accordingly.
In certain instances, shares can be sold via the (in-house) secondary market, though usually at a significant discount. For some investments booked at Credit Suisse**, the shares can be used as a collateral in a Lombard loan, freeing up some cash in case of unexpected needs.
How to implement a targeted private equity strategy for clients
For clients looking for attractive private equity solutions, Credit Suisse offers a range of different opportunities. In a first step, a client should set their target (how much to invest in PE funds). What is the commitment amount vs. the expected "out-of-pocket." The Credit Suisse SAA (balanced) recommends a 5% allocation to PE funds for portfolios > CHF 5 million. This decision then drives which vehicle can be accessed. The second step involves designing the investment strategy and deciding which strategies, managers, and vintages to include. In a third step, this strategy is then implemented with the building blocks offered by the Credit Suisse feeders, for instance.
A good starting point is the Seasons Global program, which provides access to 75-plus companies from one vintage. Larger portfolios can then add focus and target funds to steer the portfolio characteristics. For clients looking to direct deal flows, the DEP co-investment club can be considered.
* "Future of Private Markets in Switzerland – Allocation to Private Markets in Switzerland:
An Inaugural Survey" by CAIA Association and Stableton, 2022.