Key factors to assess before investing in private equity

Here’s why you might consider adding private equity to your investment strategy:

Higher return potential

Private equity investments have historically outperformed public markets over the medium and long term. Over a five-year period Australian private equity and venture capital has generated a pooled internal rate of return (IRR) of 18%, surpassing both the AXS300 and ASX Small Ords by 12% and 10% respectively¹. This outperformance is often attributed to the ability of private equity firms to identify undervalued companies, implement operational improvements, and capitalize on market inefficiencies.

Access to innovative companies

Private equity provides exposure to high-growth companies and industries that may not be accessible through traditional public markets. Many innovative startups and disruptive businesses remain private for extended periods, allowing private equity investors to participate in their growth before they go public, if they do indeed decide to list. This access to companies in sectors like technology, healthcare, and education can offer significant upside potential.

Diversification benefits

Investing in private equity can enhance portfolio diversification by providing exposure to a different set of companies and risk profiles compared to public markets. Private equity investments often have a low correlation with public equities, potentially reducing overall portfolio volatility and improving risk-adjusted returns.

Long-term value creation

Private equity firms typically take an active approach to managing their portfolio companies, focusing on long-term value creation. They often bring in experienced management teams, implement operational improvements, and pursue strategic acquisitions to drive growth. This hands-on approach can lead to substantial value creation over time, benefiting investors who are willing to commit capital for extended periods.

Alignment of interests

Private equity investments typically have longer investment horizons compared to public market investments. This longer-term focus can help align the interests of investors, company management, and private equity firms, potentially leading to better outcomes for all stakeholders.

Potential for operational improvements

Private equity firms often have expertise in specific industries and can leverage their knowledge to improve the operations of portfolio companies. By optimising supply chains, or pursuing new growth strategies, private equity firms can potentially enhance the value of their investments.

Considerations and risks

While private equity offers attractive benefits, it’s important to consider the associated risks and limitations:

• Illiquidity: Traditional private equity investments are typically illiquid, with capital often locked up for extended periods (5-10 years or more). This lack of liquidity can limit an investor’s flexibility to adjust their portfolio or access funds if needed.
• High minimum investments: In the past traditional private equity funds often required substantial minimum investments, making them inaccessible to many individual investors.
• Fees: Private equity investments can have higher fee structures. When comparing returns it is suggested to review performance net of fees.
• Risk: Investments in early-stage or distressed companies carry inherent risks, and not all private equity investments will be successful. In addition, some private equity deals involve the use of debt to finance acquisitions. While this can amplify returns, it also increases risk and the potential for losses if investments underperform.

The combination of higher return potential, access to innovative companies, and active value creation makes private equity a compelling option for those seeking to enhance their long-term investment strategy. However, it’s crucial to carefully consider your investment goals, risk tolerance, and financial situation before committing to private equity investments.