For most UK retail investors, private equity has long looked like the mythical crock of gold that is tantalisingly out of reach. But that will soon change — if the financial powerhouses behind PE have their way.
In its four-decade history, PE has largely been the preserve of institutional investors and the very rich. Billionaires and large funds, such as pensions have reaped the rewards of its rise, and committed an ever-larger share of their assets to private companies.
But faced with limited scope for further growth from institutional and high-net worth portfolios, PE managers are eyeing a broader range of individual investors.
They want to persuade savers to diversify from traditional publicly traded stocks and bonds into the unfamiliar territory of private equity.
At the same time — despite the general uncertainty in financial markets — wealthier retail investors have been demanding access to PE, envious of the above-average returns made in the past decade in everything from leveraged buyouts to tech ventures.
“All the big players are working on strategies to hit the retail market,” says Steffen Pauls, founder and chief executive of Berlin-based private equity platform Moonfare, set up to offer wider access to the sector. “In five or 10 years private equity will be for most people as common and as accessible as public markets.”
The trend of marketing PE to private individuals has picked up speed in the US in recent years and is expected to accelerate in the UK too, say people in the industry. In just one corner of the market, London-listed investment trusts focused on private companies have tripled their assets in a decade to £37bn.
But savers are urged to approach with caution.
PE is not for everybody: investing in the sector involves locking up money for long periods in products that often come with high fees and are illiquid — meaning they cannot easily be sold.
“The big problem sometimes when you talk about democratisation and tapping into retail money is that retail money is seen as being easily led and not so canny,” says Claire Madden, managing partner at London-based alternative investment firm Connection Capital. “As an asset class, it should be opened out a lot more. But it should be to the appropriate sort of investor.”
Moreover, the favourable financial conditions, driven by ultra-low interest rates, that powered the PE’s market-beating returns in the past decade seem to be fading fast.
Justin Onuekwusi, head of retail investments, Emea, for Legal & General Investment Management, one of Europe’s largest asset managers. “It’s often said that retail gets on the bandwagon last, and really gets hurt from jumping in at max euphoria.”
“You have to ask yourself: is this the right environment to be pumping lots and lots of assets into private equity? I think this is an area where we may look back and say retail really missed most of the good times.”
FT Money examines the risks and rewards of private equity for personal portfolios at a time of considerable concern about the economic outlook, which could hit PE especially hard.
What to know before you buy
Private equity has become politically symbolic for the rich getting richer. It delivered among the best returns of any asset class, but largely excludes ordinary savers in favour of big-ticket investors. “It’s one of the things that is just unsustainable because it’s unfair,” Pauls says.
The sector is most often associated with leveraged buyouts, where managers such as US-based Blackstone and KKR use debt to buy companies, then try to improve their performance and sell them on, usually after seven to 10 years.
But private equity can also encompass buying shares in any company not listed on a public stock exchange, including investment in younger companies, such as tech start-ups. Some investors think private ownership carries inherent advantages, as companies can focus on the long term instead of having to announce results every quarter or half year.
Private equity and venture capital boomed in recent years, due in part to historically low interest rates that made borrowing cheap and allowed plentiful capital for investments.
Private equity delivered annualised total returns of about 13 per cent over the past 15 years, on a risk-adjusted basis, against about 8 per cent for the S&P 500, according to Morgan Stanley research. Meanwhile, the private capital sector has grown rapidly to $8tn globally, of which 13 per cent is invested in western Europe.
“Very clearly there has been demand for higher returns, reduced risk and greater portfolio resilience,” says West Lockhart, managing director at BlackRock.
But some experts question how much those returns benefit investors, and how much goes to the managers themselves in fees. Industry standard fees include a 2 per cent management charge and a one-fifth share of returns, known as “2 and 20”.
“The only piece of the end outcome that is guaranteed is the fees,” says Tom Slater, co-manager of Baillie Gifford’s Scottish Mortgage Investment Trust. “The challenge for the end investor is that the outperformance has been captured by the asset manager or the intermediaries in their fee structure.”
Research this year by Bain, a management consultant, found that — after outpacing public markets for a decade — the performance of PE funds, net of fees, was the same last year as if the money had been put in the S&P 500. However, the top quartile of PE managers was far ahead of the public markets, the same research found, with annualised returns above 20 per cent.
So for anyone venturing into PE, picking the right manager is crucial. “Certain funds have a reputation that means they get preferential access to deal flow. They get the best opportunities. This is a self-reinforcing cycle,” says Slater.
These concerns are particularly acute now as interest rates rise and economists fret about an impending recession.
“The past 10 years in private equity have been the best years for the industry more or less ever. It was very, very difficult not to make money,” says Pauls, who previously worked at heavyweight manager KKR. “So the data of the past 10 years do not really provide great evidence for manager selection.”
Mikkel Svenstrup, chief investment officer at ATP, Denmark’s largest pension fund, this week described one element of PE — firms selling investment stakes to each other — as “potentially a pyramid scheme.”
Investors should take specialist advice and diversify across different managers, experts say. “I’m convinced we will see some well-known names not performing in the future. Now is the time when it is really most important to select managers. That’s difficult for a private individual,” says Pauls.
The biggest difference when investing in private companies rather than stocks or standard funds, experts agree, is that these investments are illiquid.
Typical private equity managers will lock up money for a period of years, giving them time to buy suitable companies, spruce them up and sell them for a profit. If investors want their money back early, they usually simply cannot.
Illiquidity is a key reason why retail has historically been locked out. Traditionally, minimum investments in PE funds would be in the millions. Even many new providers seeking to broaden access commonly have minimum tickets around £50,000.
Since these stakes should only be a small share of an overall portfolio, investors would need portfolios worth hundreds of thousands. Many routes to PE are also limited to sophisticated investors, as defined by the regulator.
Asset managers including Schroders, Abrdn, Jupiter and Baillie Gifford run private equity strategies that provide at least some form of broader access for individuals.
But investors need to be cautious even with familiar names. Looming over the sector is the example of Neil Woodford, the one-time star stockpicker. His £3.7bn fund collapsed in 2019, inflicting losses on 300,000 private investors, largely because it held too many private companies that it couldn’t sell fast enough when people asked for their money back.
“The question I get asked most is ‘Talk me through the liquidity mechanism’ It comes up in every meeting,” says Richard Hope, managing director and head of Emea at asset manager Hamilton Lane. “Understandably, people are cynical. This is an illiquid asset class. So how can you create liquidity?”
For Hope, the answer to this quandary is a relatively new type of fund known as “semi-liquid”. These vehicles are broadly similar to mutual funds but limit the amount investors can withdraw in a given period.
Popularised in the US by Blackstone, and also used for assets such as property and credit, this type of fund is increasingly being eyed for private equity.
Jonathan Moyes, head of investment research at UK private investment platform Wealth Club, says these funds will “become an enormous trend. That’s what we are putting all our chips behind.”
Wealth Club has made semi-liquid funds from Schroders and Hamilton Lane available to qualified UK investors, and plans to add more funds in the coming year, starting with one from Abrdn.
Withdrawal limits are triggered if, in aggregate, investors try to pull out more than a certain percentage of the fund’s total assets, typically 5 per cent in a quarter. In that case, a maximum of 5 per cent is withdrawn and split among the investors who want cash.
Moyes says that even with the regular withdrawal mechanism, such funds are only suitable for a long-term investor pledging a small portion of their assets. “Typically, we say this is a product for millionaires,” he says.
These funds — like direct PE investments — are not fully accessible. They are currently restricted by regulators to sophisticated investors and subject to minimum investment levels in the tens of thousands of pounds.
The withdrawal limits are most likely to bite at the time when investors most keenly want their cash back. “It sounds of course great to have . . . liquidity. But . . . it’s not a guarantee,” says Pauls. “If there is a selling market, you are probably not the only one who wants to sell.”
An alternative to the novelty of semi-liquid funds is a centuries-old British solution: investment trusts. These investment vehicles, structured as listed companies, can be used to hold private equity investments.
“The UK has the largest and most sophisticated market that has allowed for democratisation of private equity,” says Peter von Lehe, managing director of Neuberger Berman, referring to investment trusts. Neuberger Berman runs one of more than a dozen private equity trusts, investing in a range of PE funds.
Other trusts, including well-known names such as Chrysalis, provide “growth capital” for young, usually private, companies that are scaling up.
Combined, private equity and growth capital trusts have grown to £37bn in total assets at the end of August, according to the Association of Investment Companies, up from £12bn a decade ago, thanks in part to retail demand.
Investment trusts also allow managers to mix private equity with listed shares or other assets, such as property or infrastructure, in one vehicle. Scottish Mortgage, the UK’s most popular investment trust, puts up to 30 per cent of its investments into private companies.
Slater, its manager, says the trust is seeking “under-appreciated growth companies with big opportunities . . . You need to go looking for those wherever they are. Those types of businesses have been less likely to come to public stock markets in the past decade.”
The £14.6bn private equity and infrastructure trust 3i has battled with Scottish Mortgage this year for the title of the largest investment trust on the London market.
Investment trusts solve the liquidity challenge because their shares can trade freely on the public market while the assets they hold remain permanent. They don’t have minimum ticket sizes and aren’t limited to sophisticated investors.
But the downside of separating the portfolio from the share price is that investors have to cope with shares trading at a premium or a discount to the underlying value of the trust’s assets.
“A private equity investment trust is subject to what’s happening generally in public markets,” says Madden, since trusts’ share prices can swing with broad trends in the market rather than shift because of the company’s particular merits.
Also on the public markets, investors can gain a different kind of exposure to the private equity sector by buying shares in managers that have gone public, including Blackstone, KKR, Carlyle, Apollo and Ares. Goldman Sachs’s Petershill Partners has also recently listed in London.
A more direct option for investors’ with smaller portfolios is to pool their resources to invest directly in private equity deals. Several companies offer this service, bringing personal investors’ small cheques together.
Pauls, whose company Moonfare offers this service, says a key benefit is having experts choose the managers. “For a private individual who doesn’t know the industry it will be very, very difficult to pick the right fund,” he says.
Moonfare recently topped €2bn in assets under management, but remains limited to “sophisticated investors”, as defined by regulators, and has a minimum investment threshold of £50,000 in the UK.
Joining these deals means locking up investments for years, just as institutional backers do. Moonfare provides two opportunities each year for customers who need their cash back sooner to sell their stakes in an internal marketplace. The company says most customers have been able to sell, but this is not guaranteed.
Getting in early
For UK investors, one of the most familiar ways of investing in private companies comes from the world of venture capital. Venture Capital Trusts (VCTs) and the Enterprise Investment Scheme (EIS) are tax-incentivised schemes for backing early-stage British companies.
Moyes, whose company Wealth Club offers VCTs, says they are often tapped by people who have exhausted other forms of tax relief such as individual savings accounts (Isas) and pension allowances.
VCTs drew record new investments of £1.13bn last year. Madden says this is often the first way for UK investors to dabble in private company investing. But she cautions that EIS managers often invest in single, early-stage companies, “which is the most risky thing you could possibly do.”
As in public markets, diversification matters in private equity: experts advise a gradual approach spread across different managers and regions.
New structures may improve liquidity, but the fundamental problem of holding investments that are hard to sell in a hurry remain.
As PE offerings increase, investors must be very choosy. “There are going to be multiple offerings and it’s hard to differentiate between them,” says Hope. “That avalanche has not happened yet. But it will.”