Private investment in portfolios: opportunities and challenges
Ultra-high-net-worth investors and family offices see this asset class as a means to diversify and mitigate public-market risk
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More ultra-high-net-worth investors and family offices are investing in private equity – whether through direct investment or through a fund – as a way to diversify their holdings and navigate volatile public markets.
The recent Goldman Sachs’ 2023 Family Office Investment Insight Report, which is based on a survey of 166 family offices around the world with at least US$500 million in assets, reported 26 per cent of their holdings are in private equity, another 9 per cent in real estate and infrastructure, 6 per cent in hedge funds and 3 per cent in private credit.
Forty-one per cent of those surveyed also said they planned on upping their investments in private equity in 2023.
But while private equity can offer a lot of opportunities, experts caution there are both challenges and things to consider when looking at this asset class, including access to opportunities, conducting adequate due diligence, and liquidity – because with the private market, there can be higher risk but also high reward.
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How can investors get access to private investments
When it comes to any private investing, getting a seat at the table can be tough, especially if you are new to private equity, because not only do you have to be more in the know about the projects or funds, there is also usually a significant capital requirement, explains consultant Greg Gipson, former chief investment officer at Grayhawk Wealth.
“So, for many small and medium family offices, the ability to get a diversified portfolio can be a challenge,” he says.
Gipson rates access to direct opportunities, funds and fund managers as some of the most difficult challenges family offices can face when looking at more alternative investments, so there is gravitation toward the familiar when it comes to family offices diving into private equity.
Access to direct deals often open to those with familiarity in the sector
“I think in the direct space, it often works for family offices who have experience or wealth or an operating company in a particular vertical or industry,” says Gipson.
Carol Schleif, deputy chief investment officer with BMO Family Office says she sees families being drawn towards what they know, but this familiarity can be an advantage, as word of mouth about these opportunities travels in these industry circles.
“Family businesses have a lot of connections in those markets and friends come to them and say, ‘Hey, I’m going to start this business over here, or we know this, let’s three of us get together and do private real estate, so we’ll put a development company together.’”
However, this is not the only way to get into private equity and it might be an opportunity to move away from what a family business is used to and move into something completely uncharted.
Fund of funds a way to get exposure to the private equity market
A fund of funds is a way to get exposure to the private equity market, says Mat Powley, director in the private capital investment team at Stonehage Fleming, a global multi-family office based in Britain.
“The private equity fund of funds, like ours, can really tick a lot of boxes because you’re allowing a multifamily office like Stonehage Fleming, who’s been around for decades and has been investing in the asset class for over 20 years, to do all the thinking, do all the diligence, do all the heavy lifting, and all the research, knowing that it’s being professionally looked after on a full-time basis,” says Powley.
“Therefore, again, when it comes to transition of wealth, it’s something that can be the family vehicle.”
What kind of expertise is needed to do due diligence on private investments
There are many opportunities in the private equity investment class, but knowing what to choose requires an incredible amount of research and many family offices may not have the right expertise in-house to deal with this kind of due diligence.
Indeed, gathering the right data – legal, regulatory, strategic – can be difficult and time consuming.
“You’re going to get sub-docs and portfolio information. It is dozens, if not hundreds, of pages of information,” says Gipson. “For the average person, it can be challenging to fully assess the merits of the opportunity.”
How to assess fund managers
Even when it comes to indirect investing, such as through a private equity fund, there needs to be a lot of care taken when assessing a fund manager, says Gipson.
“That can be the single biggest challenge because often, the really good managers are hard to access and they often require a significant level of investment,” he adds. “For this reason, for many small, medium family offices, the ability to get a diversified portfolio can be a challenge.”
Powley recommends that, when choosing a manager, consider their history – they may look good on paper, with good returns and an impressive résumé, but this may be more the result of the past 15 years of access to cheap and easy money.
Instead, ensure these experts have experience riding out significant ups and downs because the future of the markets will likely not be as forgiving as it has been since 2007, he says.
Expertise and opportunity in volatile markets
“What we’ve seen is a lot of managers who have only known a world of ultra-low interest rates and easy money and cheap return and cheap debt, have risen a rising tide and there’s going to be a lot of casualties, I believe, in the coming 12 to 24 months,” he explains.
“Partnering with managers who have navigated through tough times is so important because when you look at these vintages now, the uncertainty, the volatility, the increasing risk, those historically are actually some of the most exciting times to deploy capital, and some of the best times to invest if you get it right and get the managers right.
“There’s opportunity in there and uncertainty creates opportunity.”
If there is an opportunity that presents itself, Gipson recommends, “a healthy dose of skepticism.”
“If someone’s pounding on your door, you probably want to wonder why they’re pounding on the door,” he adds. “For 26 years, I’ve used this same phrase: ‘Trust but verify.’”
Diversification is key in choosing private equity funds
But even with all the research, it’s important not to put all your money into one investment.
“In reality, in the private space, any one manager, any one vintage, or any one fund could be bad. It just happens,” says Gipson.
“You could just happen to have invested with the right manager at the wrong time. If you only make that one investment, you’re stuck with it. You often don’t find out until year seven in a 10-year fund. Access, analysis and diversification, in my mind, are the three biggest challenges that the average investor faces.”
Consider liquidity when choosing private equity investments
Schleif cautions anyone getting into the private equity space to consider their liquidity because private equity money can be locked up for significant amounts of time, depending on the vintage year (the lifespan of a private equity fund).
“You’re realistically talking 10 to 15 years’ worth of having the capital locked up,” she says.
“We saw this with a lot of college endowments back in the 2000s because they all went charging hard down the path of … locking up a whole bunch of [private investments] and then all of a sudden the small percentage they had left in the public market shrank by 25 per cent.” This resulted in being compelled to sell off some of the holdings “at fire sale prices.”
However, there are ways to gain exposure to private equity without getting in at the early stages, which could help with liquidity issues, she adds.
A secondary, where one investor buys an existing interest in another investor’s asset, is one option, Schleif says.
“You don’t have the same drawbacks that you do in doing early-stage venture or early-stage private capital of some sort, where you’re sending a lot of money out the door before you get any back in,” she says.
“With secondaries, you can still be sending money out the door even while you’re getting money back in.”
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