Should advisers be increasing the allocations to private equity they hold in clients’ portfolios? New research suggests the answer is yes, with private equity potentially increasing both absolute returns and risk-adjusted performance.
The study, published by Pantheon, looked at portfolios of alternative assets, rather than conventional portfolios of equities and bonds. Alternatives feature increasingly prominently in the plans of private client wealth managers, stockbrokers and retail investors themselves, offering diversification benefits and, often, attractive levels of yield. But Pantheon says such portfolios often overlook private equity.
This is potentially a mistake. Tracking back, Pantheon looked at the performance of two different portfolios over the past 10 years. The first included equal allocations to gold, hedge funds and real estate; the second added private equity to the mix.
The impact of private equity turned out to be significant. The second portfolio outperformed the first by an average of 2.4% a year. And while it was more volatile, the extra return more than compensated for the extra risk.
This is, of course, just one study, looking at a distinct historical period of investment returns. But the boost given by private equity was so significant that it’s worth taking account of. And there are good reasons for that boost: private equity, offering exposure to fast-growing, often immature unlisted businesses - all through the prism of professional management and an ecosystem of support - does have an outstanding long-term performance record.
That begs the question of why intermediaries and individual investors have not embraced the asset class to the extent one might expect. The explanation is complex but most of the factors centre around access. Private equity has traditionally required very large commitments to illiquid funds – most investors simply do not have the capital to meet minimum subscriptions and are not happy to lock their money in for extended periods.
However, listed private equity funds resolve these difficulties. The 20 or so funds in the investment companies industry’s private equity sector offer a highly liquid and affordable route into this universe. Just like other investment companies, their shares are tradable on the open market, meaning investors can get in and out as they desire, investing as much or as little as they are comfortable with.
It will be interesting to see whether the Covid-19 crisis prompts increased interest in these funds, with investors on the look-out for bargains.
Private equity traditionally fares worse during periods of market turmoil, since there may be uncertainty about the true value of funds’ portfolios, particularly compared to listed assets. And many private equity investment companies have been through a torrid time in recent months; shares in the average fund in the sector currently trade at a discount to the underlying assets of just over 10%, but the figure is substantially larger in many cases.
Some advisers and investors will see this as an opportunity to increase their exposure to the private equity industry, in search of the performance benefits identified by Pantheon’s research. In which case, we may see allocations to private equity, with all the potential advantages it brings, begin to increase.