Who are the investors, who are the world’s largest managers, and how much and how non-qualified investors should invest in private equity
How to and how much to invest in “private equity”?
The main private equity investors are big institutional investors such as pension funds, insurers, sovereign wealth funds and family offices
The main private equity (PE) investors are institutional investors, such as pension funds, as can be seen in the following chart for the US case:
The main private equity investors are public pension funds with 43%, followed by asset managers with 13%, insurance companies with 11%, sovereign wealth funds with 7%, and endowments and private pension funds with 5%. We see that they are fundamentally very long-term investors.
The allocation of these institutional investors is based on the assumption of high absolute and uncorrelated returns.
The following chart shows private equity fund capital raisings by type of investors in several European countries or regions:
In the UK, the breakdown of major investors closely follows the case of the US, being dominated by pension funds, sovereign wealth funds and insurers. In central European countries, the largest investors are corporates and family offices with about 20% each. In Francophone, Nordic and Southern European countries, the main investors are fund of funds, with between 26% and 35%. In Eastern European countries the main investors are government agencies with 39%.
A portion of private equity capital is provided by High Net Worth (HNW) and Ultra High Net Worth Individuals (UHNW) through Family Offices and Fund of Funds. Their asset allocation is as follows:
Affluents or HNWI invest 22% of their wealth in alternatives and the UHNWI, ie very rich or multi-millionaires, 46%.
The following graph shows the allocation of the assets of these investors groups within the class of alternatives:
HNWI allocate 35% of alternative investments to private equity, and UHNWI 52%.
The largest private equity firms are based in the US and UK, although there are already several spread around the world, ranging from traditional restructuring specialists such as KKR or 3i to Andreessen Horowitz’s internet flagships
The 25 largest private equity firms hold $1.8 trillion in assets under management (AUM):
The following graph shows the evolution of the size of the world’s 4 largest private equity firms between 2012 and 2019.
We see that these 4 largest companies, consisting of Blackstone, Apollo, Carlyle Group and KKR, have gotten even bigger over this period, more than doubling the assets under management.
In the following chart we see the evolution of the stock market capitalization of the 4 largest private equity firms compared to some of the largest managers of active investment funds and Blackrock, the world’s largest passive fund manager, since 2014:
The success of the private equity industry in this period is evident, showing an increase in the stock market value that only matches that of Blackrock, almost doubling the market capitalization, and very contrasting with the loss of almost 50% of the value of the companies managing active funds.
How to and how much to invest in private equity?
The most obvious way to invest in private equity is to do it directly in private equity funds. This is only accessible to institutional investors and to very wealthy individuals, given the capital and qualification requirements.
There are two more indirect ways to invest in “private equity”, which avoid the need of big sums of money, making it possible to invest in lower amounts.
The first is through investing in stocks of private equity firms, although and as we will try to show the exposure is not the same.
There are several private equity investment firms (PE) – also called business development companies (BDCs) – which have shares listed on capital markets.
In addition to the Blackstone Group, there is Apollo Global Management (APO), Carlyle Group (CG) and Kohlberg Kravis Roberts (KKR), best known for their massive leveraged purchase of RJR Nabisco in 1989.
The following chart shows the performance of the shares of the world’s 4 largest private equity firms compared to the Dow Jones index in the period 2007-2016:
The performance of the investment in the stocks of private equity firms is worse than that of the Dow Jones. The value of Blackstone’s investment in 2016 is still below the value of its price listing in the midst of the financial crisis in 2007, and the most recently listed Apollo or Carlyle Group is also below the water line. Only the investment in KKR performed quite positively, in line with that of the Dow throughout the period, but much better in the early years.
Overall, this form of investment is uninteresting. This is because we are investing not a specific private equity fund, but rather in a cluster or basket of funds, and we have seen beforehand about the importance of selecting the best funds well.
The second indirect way to invest in private equity is through private equity fund of funds.
Investment funds have restrictions on the purchase of private equity (PE) due to securities and exchange commission (SEC) rules on illicit securities holdings but may invest indirectly by buying private equity (PE) funds. These investment funds are commonly referred to as fund of funds.
Unqualified investors may also acquire units in exchange-traded fund (ETF) that hold shares of non-publicly subscribed capital (PE) companies, such as ProShares Global Listed Private Equity ETF.
Traditionally, fund of funds have played a crucial role in allowing investors access to private equity.
By offering access to a portfolio of private equity funds, the funds allow smaller investors, who cannot commit large amounts of capital through multiple funds, to gain the benefits of diversification.
In addition, investors have the investment experience of the fund manager, with the expectation that the benefits of choosing better performing funds outperform the additional costs introduced by the fund funds and consisting of a double tier of fund commissions (typically a 1% management committee and a 5% or 10% success or performance commission on earnings, in addition to the underlying fund fees).
The world’s largest closed funds between 2009 and 2017 worldwide were as follows:
Finally, as far as investing is, our view is that private equity investment should not be made by private or individual investors, even HNWI, with a few exceptions.
As we have seen before, private equity investment must be made by professionals or qualified investors, mostly institutional long-term, as it requires a deep knowledge and experience in the matter, in addition to a very long investment horizon.
UHNWI and HNWI who succeed in “private equity” are those who have a great knowledge and experience in these investments and are part of the narrow circle of investors invited to participate on a recurring basis by the best managers and private equity funds.
