What do your clients really know about private equity investment opportunities? They can be forgiven their skepticism in the wake of the PE implosion in 2008. But today, opportunities abound for the diversification, enhanced return potential and access that private equity now offers.
Endowments, public and private pension funds, and high net-worth individuals have allocated to private equity (PE) for the past three decades as the asset class has traditionally outperformed other investment options. According to the NACUBO-Commonfund Study of Endowments, the average endowment had an asset allocation of 14% to private equity in 2012.
Private equity firms are now targeting mainstream investors with new products as the market for institutional money has crested, while new legislation such as the Jumpstart Our Businesses Startups (JOBS) Act has simplified the process for firms to raise money from retail investors.
Here are seven considerations for advisors in preparation for the coming onslaught of PE product announcements:
1. Due Diligence and Performance of PE Manager – According to Preqin, a PE information service, top-performing PE managers tend to show persistent outperformance over time. Advisors should research a management team’s background and performance record before investing in a particular fund or product.
2. New Terminology – PE products come with a unique set of acronyms and terminology. Advisors should understand these new terms before investing.
3. Role in Client’s Portfolio – PE products have different benefits and risk profiles. Advisors should understand how these products fit within their client’s investment objectives and explain the risks and benefits of products, such as venture capital vs. distressed debt vs. mega-cap buyout strategies.
4. Liquidity and Lock-up Provisions – Advisors should understand all special considerations in buying or selling the product and be able to explain that process to their clients.
5. Transparency and Diversification – With many PE products, investors do not have information on the underlying holdings of the PE investment. Advisors should understand if the product provides PE diversification, i.e., across managers, funds, vintage years, stages of investment, geographies, investment types and industries. If not, the advisor may need to combine multiple products to create a diversified PE portfolio.
6. Fees, Sales Charges and Expenses – Many PE products will include one or more layers of fees, sales charges and expenses. Advisors should understand how management incentives align with investor interests, the net return to investor after all fees, and be able to explain various fees such as carried interest, management fees, and affiliated fund fees and expenses to their clients.
7. External Managers – For advisors who want exposure to PE but do not have the expertise or time to research these products, consider using external managers who can build, monitor and manage a diversified portfolio of PE investments.