In a world of low returns, discerning HNW investors are turning to the fast-moving universe of private equity investments, writes Bill Nixon
With interest rates testing all-time lows, the equity market looking overvalued, and alternative investments like hedge-funds offering mixed results, it is perhaps not surprising that an increasing number of high-net-worth individuals (HNWs) and families are channelling capital into private equity.
Of the $4 trillion in private equity assets across the world, family offices account for 8 per cent, twice as high as five years ago. Palico, an online marketplace for private equity, found that family offices and HNW individuals who have over $10 million in investible assets have increased their average portfolio allocation to private equity by more than half. This means they are now investing an average of 30 per cent of their portfolio in private equity, making them the highest capital allocators to private equity.
The trend also marks a departure from traditional, fund-based private equity investment, with two-thirds of HNW investment now through co-investing. This coincides with the ascension of the ‘self-directed’ investor, which will likely continue as younger generations accumulate wealth and embrace a more tailored attitude to investing.
A more direct co-investing strategy gives investors greater control over their capital commitments, allowing them to create bespoke portfolios according to their individual objectives and sector preferences. This strategy can prove extremely cost effective, considering that private equity fund fee structures often match those of hedge funds, with a 2 per cent management fee and 20 per cent performance fee. Indeed, private equity returns have been outperforming hedge funds in recent years.
For the more adventurous HNWs and family offices, always on the hunt for the next thrill, co-investment is a chance to indulge their entrepreneurial spirit. Second and third generation HNWs, whose understanding of the sector often runs deeper than that of their parents or grandparents, relish the opportunity for direct involvement. With connections in every corner of the sector and, indeed, the world, they also have access to experts who, on occasion, can provide meaningful assistance or commercial input to the investment manager.
On the other end of co-investment deals are private equity managers themselves, who are attracted by enhanced buying power and greater exposure. Co-investment may also ease the burden of a deal which requires a fund to commit too much to a single deal.
HNW co-investments have been a key driving force behind the private equity’s recovery from the financial crisis, which, with fundraising now back at pre-2008 levels, is almost complete. HNWs with entrepreneurial background have been a huge asset to private equity managers because they provide access, with the help of an extensive entrepreneurial network, to the most attractive acquisition prospects and off-market deals. Likewise, a relationship with a well-connected family office investor with the ability to deploy capital quickly, may make it easer for private equity firms to secure a good deal.
This is an important strength, at a time of intense competition for the best assets. The competitive bid process has resulted in buy-out firms paying an average premium of 31 per cent over the initial price, according to data compiled by Bloomberg. This represents an eight-year high.
In order to keep up with recent trends, some family offices are even setting up their own private equity firms.
Family offices tend to construct their portfolios to reflect their allocation requirements, investment aims and risk profiles, with a preference for sector diversification to minimise their exposure to any one industry. Maven’s family office and HNW investor partners typically invest in four to six opportunities a year, allocating between £100,000 and £1 million in each transaction, in investments which are held for an average period of around five years and have a target return of 2.5 times or more
The future is looking bright for the private equity sector, and I expect it to show even greater improvement. Regular co-investment can be something of a virtuous circle because of the importance of building trust and establishing a comfort level for the investor. As HNWs and family offices gain confidence and learn to navigate the private equity universe, they are likely to seek more deals.
At a time when the outlook for returns from more traditional asset classes is uncertain, I expect these groups of investors to account for a significant share of the anticipated growth in private equity over the next decade.
Bill Nixon is the managing partner at Maven Capital Partners