As an outsourced chief investment officer that is fairly active across all asset classes, we’ve really noticed a pick-up in investor flow into the private equity market. This shift isn’t unusual: low interest rates have already motivated investors to seek out higher yields in the private debt market and now a moderating outlook for equity returns is causing some to look toward private equity to torque up their portfolios.
The problem is that this strategy isn’t without risk — and at times a lot of it, especially if one is new to investing in the space. If an investor’s portfolio isn’t large enough, there is the risk that one or two bad deals could blow up a large portion of his or her net worth.
These risks should not scare investors off private equity, but they highlight how important it is to do a bit of homework first. It also helps to follow the lead of those who have successfully been involved in the space for a full cycle and understand how to manage liquidity, transparency, diversification and risk. With that said, here are a few rules to keep in mind if you are considering adding private equity investments into your portfolio.
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No more than a 5 to 10 per cent allocation
Institutions including pension plans, endowments and foundations have been investing in private equity and debt as an asset class for some time now. Their large asset bases have allowed them to take a very long-term approach when investing, even as their total allocation to the space often amounts to no more than 5 to 10 per cent of their total portfolio.
For the regular high net worth investor with a million-dollar portfolio, a $50,000 allocation doesn’t provide a lot of ammunition. A person in this position should consider whether it is even worthwhile undertaking the time and diligence required before investing in the space.
We would argue that only those with a minimum portfolio size of $3- to $5 million should consider entering the space.
Avoid brokered exempt market deals
Because of their size, institutions are able to source and access high-quality deal flow via their networks, whether it be co-investing directly with their peers in projects or companies, or utilizing some of the best private equity fund managers on an exclusive basis.
However, it’s a bit of a different story for average high net worth investors, who for the most part have had to rely on high-fee, high-risk retail deals offered through their brokers.
In this regard, we have yet to invest in a single brokered private equity offering in the exempt market on behalf of our clients despite a plethora of deals being offered.
Instead, we think high net worth investors should seek out a more diversified approach by investing in a handful private equity funds run by management teams that have ownership themselves, an established track record, full transparency regarding their investments and regular and consistent communication. These managers have the expertise required to not only source quality deal flow but also help those direct investments along via board-level advisory.
While an advisor can help you sort through which funds to invest in, you should ensure that he or she is not compensated by the funds in any way, to avoid any conflict of interest.
De-risking through technology
Finally, we’ve not only come across but also invested in some very interesting fintech platforms that allow qualified investors to take on positions as small as $10,000 per deal. Deals are pre-screened with a lot of in-depth information and transparency into the opportunities being presented.
Platforms like these enable investors to build out a diversified portfolio of 10 to 15 private equity investments or specialty funds in exciting areas such as cognitive computing, artificial intelligence, Internet-of-Things and Saas.
In conclusion, we think private equity should be a component of some high net worth portfolios, but don’t allow current public markets to be the sole motivator for making this decision.
Martin Pelletier, CFA is a Portfolio Manager and OCIO at TriVest Wealth Counsel Ltd, a Calgary-based private client and institutional investment firm specializing in discretionary risk-managed portfolios as well as investment audit and oversight services.