Private equity – Feature
A golden age of private equity has ended and debate is rising over contrasting interpretations of the asset class. One has it as a megatrend – an interesting idea – of which investors should, like most megatrends, be part of. The alternative, more critical, interpretation has it compared to a pyramid scheme. These are two diverse views, on what is an important alterna- tive investment class for investors.
The megatrend perspective is a new take on familiar territory. A continuation of the upbeat outlook that has dominated since the financial crisis, where private equity received a boost from ultra-low interest rates and was welcomed by institutional investors looking for yield. This was evident in 2021, which was a record year for the asset class with investment activity sur- passing the trillion-dollar mark for the first time. Such moves by investors have proven well placed. Private equity delivered strong annualised total returns of about 13% during the past 15 years, on a risk-adjusted basis, against around 8% for the S&P500, according to Morgan Stanley. It is not surprising, therefore, that some people refer to this period as the golden age of private equity.
Bottom of the pyramid
The benefits of private equity are coming under scrutiny, but, as Andrew Holt finds, that is no reason to sell your allocation just yet.
The pyramid scheme allegation is more complex. The issue of private equity firms selling their assets to each other at inflated prices is where this idea has developed. It is an unedifying and worrying investment spectacle – hence the pyramid scheme comparison – and one that has slowly become more prevalent in private equity. Stephen O’Neill, head of private markets at Nest, agrees that this is an issue. “It can certainly seem like some private equity funds sell companies to each other at ever higher valuations and that in some instances, a company’s post-IPO stock price suggests those valuations might have been inflated,” he says. “Such examples are notable for their rarity and tend to occur in either the large cap space or amongst young companies in the venture capital/technology space,” he adds. But Nest has a way of staying away from this scenario. “That’s why at Nest we focus primarily on middle market companies and growth equity, where the private equity manager can imple- ment a clear and intuitive business plan and expand a company’s margins – which in turn warrants a higher valuation for that company and hence good returns for investors,” O’Neill says. The situation can be dealt with from an investor perspective in other ways. Matthew Cox, investment director at charity Esmee Fairbairn Foundation, which has around 35% of its assets in private equity (see page 14), has another approach. “As with any asset class, it depends on who you partner with to manage your money,” he says. “We have seen private equity come and go. It is not just about being in the asset class, it is about being with the right manager within that asset class.”
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