A Nontraditional Standalone Asset Class
Private Equity: A Nontraditional Standalone Asset Class
Private Equity is generally regarded as an asset class that offers investors the opportunity to achieve superior long-term returns when compared to traditional public stock and bond investment vehicles while delivering diversification from these public investment alternatives. The long-term high returns of Private Equity represent a premium over the performance of public securities, primarily due to their participation in an inefficient, vast, and growing marketplace of privately held companies not accessible via traditional investor products, as well as their ability to create value by proactively influencing portfolio companies’ management and operations. Investors generally have access to Private Equity deals through (1) direct investment in a deal, (2) investment into a Private Equity fund that makes many investments, or (3) investment into a fund of funds, which invests across several Private Equity funds. Private Equity can refer to a wide variety of investment styles and even non-equity securities. Ironview’s structure allows for flexibility to opportunistically capitalize on various investment classes such as:
Late-Stage Private Equity / Leveraged Buyouts (LBO’s)
Venture Capital (Angel Investors or Seed Investors)
Historical Private Equity Risk & Performance
In recent studies examining the returns of Private Equity and other asset classes such as publicly-traded equities and bonds, Private Equity (ex-Venture Capital) has outperformed on both an outright and risk-adjusted return basis (as measured by the Sharpe Ratio, a measure of the excess return of an investment over the risk-free rate per unit of risk). While these studies may have some selection bias for successful funds, as well as exclude the performance fees associated with typical funds, generally Private Equity has outperformed as an asset class. (1)
In addition to generating superior returns over the long run, Private Equity generally outperforms in negative performance environments, acting as a buffer to an investor’s portfolio against the more pronounced swings in the public markets.
Private Equity as a Diversifying Asset Class
In addition to generating superior returns, Private Equity can act as an innovative diversifier when combined with more traditional asset classes. Historically, Private Equity has been less correlated to public markets than other asset classes, and the addition of an allocation to Private Equity increased returns while decreasing risk, as demonstrated in the tables below. While this relationship broke down to some extent during the financial crisis (as almost every asset class was negatively impacted), we expect that over the long-term Private Equity will remain an important diversifier in a portfolio, as well as a source for excess returns.
In particular, there is an opportunity within the small-cap Private Equity space, as the percentage of total deal volume for deals under $50 million in value often is only a few percent of all deals completed in the space. This implies a less competitive market and the potential for higher returns.
One compelling feature of smaller Private Equity deals is that they have not come to rely on cheap debt financing the way larger deals have. Even though less debt financing would by itself imply lower returns (though less risk), this is not the case with smaller deals as the lack of leverage is made up for by the improved deal dynamics (less competitive bidding) and increased room for operational improvements in portfolio companies at the smaller end of the size range.
(1) Source: Cambridge Associates, FactSet, Voya Investment Management. Private Equity is represented by Cambridge Global Private Equity Index, 10/95-9/15.