Private Equity Investments

[bbuzzard]

Given that quality fund-of-funds investments in private equities can be entered for $250k, it seems that his would make sense for many FIREd who could devote 10-20% of their portfolio to this asset class. However, I have never seen any discussion of this topic on the board. What does everyone think? I am at the very preliminary stages of considering taking a 10% position in this type of investment.

 

[doushioukanaa]

Private equity is all the rage out there in the media, and therefore it is overdone in my opinion. The fees and risks are high, and is there any evidence it would return any better than a leveraged investment in stocks? If you want private equity risk and return, take out a home equity loan and put the proceeds toward a good batch of low fee mutual funds or ETFs.

I am interested though, which fund of private equity funds are you looking at, and what is their pitch? How much do they cost?

 

[LOL!]

$250K is 10% of $2.5million, so based on earlier polls, that would make it available to about 3 people who frequent this forum. I ain't one of them.

 

[FinanceDude]

Private equity is all the rage out there in the media, and therefore it is overdone in my opinion. The fees and risks are high, and is there any evidence it would return any better than a leveraged investment in stocks? If you want private equity risk and return, take out a home equity loan and put the proceeds toward a good batch of low fee mutual funds or ETFs.

How is that good advice?? :

 

[FinanceDude]

Given that quality fund-of-funds investments in private equities can be entered for $250k, it seems that his would make sense for many FIREd who could devote 10-20% of their portfolio to this asset class. However, I have never seen any discussion of this topic on the board. What does everyone think? I am at the very preliminary stages of considering taking a 10% position in this type of investment.

Are you talking private placements, or limited partnerships?

 

[mathjak107]

funny story, fidelity investments has a private investment arm. i wrote them asking them to send me information about taking a position in their company

2 days later i get an employment package


i guess i did say "POSITION"

 

[saluki9]

Are you talking private placements, or limited partnerships?

I don't think he's talking about either one. He's talking about a direct investment into a fund.

I do think private equity has a lot going for it and is a good asset class. The problem is similar to individuals buying into hedge funds. The funds that actually want your money usually aren't the good ones.

 

[brewer12345]

Further to Saluki's comments, this is also NOT the time to be shoving money into a private equity fund. There is already too much money chasing deals, which inevitably means that bad/overpriced deals are being done. Then you add in the multiple layers of fees for the manaers of both the private equity shop and the fund of funds and it becomes pretty unattractive.

 

[audreyh1]

Given that quality fund-of-funds investments in private equities can be entered for $250k, it seems that his would make sense for many FIREd who could devote 10-20% of their portfolio to this asset class.

How can this be considered an "asset class"? It's not one particular type of investment that has a historical well understood correlation with other asset classes like bonds, REITs, commodities, etc.

It's just kind of generic "equity". I guess at most it could be considered "small or micro-cap growth" in the traditional sense of venture capitalism, but I know larger companies are being taken private too these days.

10-20% of portfolio? I don't think so.

fund-of-funds usually means lots of layers of fees.

Audrey

 

[brewer12345]

How can this be considered an "asset class"? It's not one particular type of investment that has a historical well understood correlation with other asset classes like bonds, REITs, commodities, etc.

Actually, I had required reading in a portfolio management textbook that included a discusion of private equity and venture capital as separate asset classes. Different animal than standard equity.

 

[magellan_nh]

Further to Saluki's comments, this is also NOT the time to be shoving money into a private equity fund. There is already too much money chasing deals, which inevitably means that bad/overpriced deals are being done.

The company I retired from was in tough shape with declining revenues and a $10-20M loss each quarter. There had been rumors for years that a buyout was in the offing, but it never materialized. Revenues were around $70M per quarter and shrinking fast.

Then, out of nowhere, a private equity consortium made an offer of $300 million. This was about a 20% premium on the stock price (which was around 1/40th of the alltime high). The deal closed and the first thing they realized was that the "big new project" , that was sold as the salvation of the company and had received around $150 million in R&D money during its 3 years of development, was junk. Around 80% of the company's engineers were working on this new product.

The money quote on this deal was from a friend of mine who's a big reseller of the company's products. Shortly after the deal closed, he got a friendly call from the new CEO who wanted to reassure the reseller that there were great things in store for the company. In passing, the CEO asked what percent of the resellers business was with the new product. The reseller answered 5 to 10. The CEO said "only 10%, really?". The reseller answered back, "No, actually I've only sold 5-10 systems" and every customer made me take the system back because it didn't work. I refuse to sell it anymore. My friend said you could hear the CEO's jaw drop on the other end of the line. That was about 2 weeks before the mgmt bloodbath and the big restructuring.

In the end, I suspect the investors that funded this deal will lose at least half of their capital. To me, this is proof positive that there is too much money chasing too few good deals in this space. Also, in their rush to close deals I suspect due diligence is lacking.

It reminds me a lot of the late 90s when tech companies were buying startups for crazy prices with hardly any due diligence. I was part of a due diligence team of several deals at my old company (probably totalling around $800M). In those days, the pressure to rubber stamp each deal was huge and a lot of junk was purchased. It looks very familiar now with private equity.

Jim

 

[saluki9]

Actually, I had required reading in a portfolio management textbook that included a discusion of private equity and venture capital as separate asset classes. Different animal than standard equity.

Much much different. The management of a company can create a lot more value when they don't have to report quarterly numbers to analysts.

 

[brewer12345]

Much much different. The management of a company can create a lot more value when they don't have to report quarterly numbers to analysts.

Heh, as long as they can keep up with their debt load and take a big enough sponsor dividend before things get hairy.

 

[audreyh1]

Actually, I had required reading in a portfolio management textbook that included a discusion of private equity and venture capital as separate asset classes. Different animal than standard equity.

Yeah but was that in the classic "asset allocation" portfolio where X% of this asset class provided some benefit to improve risk-adjusted performance of a portfolio due to lowish correlation with other asset classes? I guess I tend to use the term asset class in this more limited case - that's why the average joe might want to own X%.

I was mostly responding to the OP using it in this context.

Audrey

 

[brewer12345]

Yeah but was that in the classic "asset allocation" portfolio where X% of this asset class provided some benefit to improve risk-adjusted performance of a portfolio due to lowish correlation with other asset classes? I guess I tend to use the term asset class in this more limited case - that's why the average joe might want to own X%.

I was mostly responding to the OP using it in this context.

Audrey

What are you trying to say? What other context other than "classic" would one use the term "asset class"?

 

[audreyh1]

I mean in the sense of asset allocation and modern portfolio theory. I have just never seen "private equity" listed as one of the asset classes to include in the mix.

Audrey

 

[bbuzzard]

I don't think he's talking about either one. He's talking about a direct investment into a fund.

You are correct. I have a little advantage at I have a very close relative who runs the private equity investments portfolio for a large teacher retirement system (managing $Bs in PE investments). He tells me that it is not an appropriate investment for an individual, But OTOH, he does not know how large my assets are. I think he thinks I would be takinga 50% position rather than a 10% position. Anyway, he has all the inside scoop on the various PE firms, and is willing to review my options with me, as well as try to convince me not do do it.

 

[doushioukanaa]

How is that good advice?? :

Many people including the media conflate private equity, hedge funds, LBO firms, and venture capital, regardless of what the textbooks say. Along with the customary 1% to 2% management fee on the investment net asset value, these funds typically keep 20% of the profits generated each year as payment. Often all they do is use options or debt financing to increase returns. They go to Las Vegas with your money, keeping a good portion of the upside while you bear all the risk. Some of them do a good job of it.

The quote above from FinanceDude was in reaction to my suggestion that an investor could simulate private equity risk/return by simply taking out a loan (tax deductible if it is home equity) and then investing it herself in some good, low fee stuff. If the funds are particularly good, they buy the companies that the private equity firms subsequently buy at a big premium, thereby getting a cut of the action everybody is talking about. By approaching it this way, you eliminate the middleman and the highway robbery fee structure of private equity while goosing returns in the long run. Sure, you don't get the peace of mind associated with reduced or zero debt, and you can still incur losses in the short or medium term, but remember I was only suggesting it as an alternative to private equity, not a generic strategy for the most FIRE'd people. I think it a very sound alternative to private equity and would be interested to hear why FinanceDude suggests it is not.

 

[FinanceDude]

Many people including the media conflate private equity, hedge funds, LBO firms, and venture capital, regardless of what the textbooks say. Along with the customary 1% to 2% management fee on the investment net asset value, these funds typically keep 20% of the profits generated each year as payment. Often all they do is use options or debt financing to increase returns. They go to Las Vegas with your money, keeping a good portion of the upside while you bear all the risk. Some of them do a good job of it.

The quote above from FinanceDude was in reaction to my suggestion that an investor could simulate private equity risk/return by simply taking out a loan (tax deductible if it is home equity) and then investing it herself in some good, low fee stuff. If the funds are particularly good, they buy the companies that the private equity firms subsequently buy at a big premium, thereby getting a cut of the action everybody is talking about. By approaching it this way, you eliminate the middleman and the highway robbery fee structure of private equity while goosing returns in the long run. Sure, you don't get the peace of mind associated with reduced or zero debt, and you can still incur losses in the short or medium term, but remember I was only suggesting it as an alternative to private equity, not a generic strategy for the most FIRE'd people. I think it a very sound alternative to private equity and would be interested to hear why FinanceDude suggests it is not.

So you believe taking out debt on a house to invest in the market? Were you alive in 1999 when that was all the rage? I think we all remember how thay ended up............ : :

 

[doushioukanaa]

So you believe taking out debt on a house to invest in the market? Were you alive in 1999 when that was all the rage? I think we all remember how thay ended up............ : :

Dude,

I believe it is a superior strategy to investing in private equity, yes, especially since market P/E's are not quite as high as they were in the late '90's. I did not suggest it as a generic strategy for most of us to undertake, so I would appreciate if you would not put words in my mouth. Are you suggesting that investing in private equity fund of funds is superior to making a leveraged investment in a diversified portfolio of good low cost funds? A simple yes or no would do.

 

[saluki9]

I mean in the sense of asset allocation and modern portfolio theory. I have just never seen "private equity" listed as one of the asset classes to include in the mix.

Audrey

I don't mean this as an insult, but you must not have read a lot of papers or books on MPT. Private equity is on all the EFs I've seen.

Many times for individuals it is left out of the optimization, but it's mean return and volatility #s blow away most other asset classes

 

[brewer12345]

, but it's mean return and volatility #s blow away most other asset classes

I might be inclined to take issue with this statement given the inherent difficulty of measuring volatility when there is no quoted price for the asset. But its kind of beside the point here.

 

[saluki9]

I might be inclined to take issue with this statement given the inherent difficulty of measuring volatility when there is no quoted price for the asset. But its kind of beside the point here.

No doubt it's harder than with an asset that is marked to market every day, but there are methods of estimation. Most of the data I've seen is calculated with the quarterly returns submitted by the funds themsevles then adjusted with the terminal returns once the fund closes out.

Not the best, but it is something.

 

[brewer12345]

No doubt it's harder than with an asset that is marked to market every day, but there are methods of estimation. Most of the data I've seen is calculated with the quarterly returns submitted by the funds themsevles then adjusted with the terminal returns once the fund closes out.

Not the best, but it is something.

Great, but it is apples to oranges when comparing the mean variance characteristics of a publicly traded asset class. As such, making such comparisons is a little iffy, so I wouldn't want to have to stand on them. Same problem with hedge funds real estate, art, collectables, etc. Doesn't mean it is a bad choice/addition to a portfolio, just that I wouldn't want to have to mount a rigorous defense of the high return-low volatility claim.

 

[bbuzzard]

Very intesting so far, by regarding my question. Does anyone here invest in these vehicles, and if you don't but have the assets to do so, why don't you?

The preliminary data I have seen suggest PE returns blow away publicly traded equities. Of course, the data set is very young and very small, and past returns do not guarantee future returns .