Investing in Private Equity
Private Equity is the term given to investment in unquoted equities. There are many different types of Private Equity investment but by far the largest and commonest element in the UK is in leveraged buy-outs or buy-ins. Private Equity managers acquire public companies or divisions of them, increase financial gearing (leverage) to much higher levels than would be normal in a quoted equity and seek to improve returns in other ways. Once these changes have been made the investment is sold.
Private Equity returns, over the long term have tended to be better than those from quoted equities. It should be noted, however, that this has been at least partly a function of using higher leverage. In this respect it is arguable that the higher returns are necessary in order to compensate for higher risks.
Proponents of Private Equity argue that returns from this asset class are not strongly correlated with quoted equity returns. We are sceptical of this claim because the valuations at which Private Equity investments can be realised (either by a public offering or by a trade sale) will ultimately be related quite closely to quoted equity valuations. It is true that Private Equity investments tend to be held at cost until there is a clear and strong reason to mark down or up but we do not believe that this accounting convention necessarily reflects the underlying reality.
We consider that Private Equity investment should only be considered by investors seeking to enhance portfolio returns and willing to accept higher risk. We do not consider Private Equity to be an asset class that is suitable for diversifying equity risk.