|What defines Private Equity ?
Private Equity can be basically described as the fact to invest either in companies that are not trading on a public exchange, or in a publicly listed company with the goal to delist them.
The essence of Private Equity is to provide long-term capital to companies that are unlisted and cannot easily raise equity or debt from individual investors and mutual funds.
In the case of publicly traded companies that are buy out, the goal of private equity investors is to help the target companies’ management to focus on their core business and to improve their operating and financial performance with the support of their shareholders.
|Four distinct strategies of Private Equity
The first one is through Leveraged Buyout (LBO), which is a strategy focused on mature companies with proven track record, which allows higher capacities of investment.
The second one is through Venture Capital (VC), which is a strategy focused on earlier stage companies, such as start-up, and so is a riskier investment than LBO.
The third is Mezzanine Debt, which is a hybrid investment since it includes an equity kicker.
The fourth is Distressed Debt from companies that are in financial turmoil.
|The Private Equity investment process
Institutional Investors, which are the main provider of capital, invest in Private Equity as limited partners through Private Equity Funds. These funds are managed by Private Equity Firms, as general partners. The portfolio companies’ equities are held by these vehicles, which typically last 7 to 10 years.
Listed private equity firms and the ETFs based on them tend to have a relatively high correlation to the S&P 500 index, but tend to exhibit a beta well above 1.
Investors tend to benefit from high dividend yields from these listed companies: KKR yields 7%, while Blackstone offers a 7.2% yield.
|Private Equity’s fees, risk and reward
The typical fee structure for both LBO and VC funds ranges from 1% to 3,5% for management fees and from 20% to 30% for performance fees. Most of these funds include a covenant, which is called a clawback provision, to allow investors to receive back previously paid incentive fees if the net performance fall bellow the per value.
Both LBO and VC’s life cycles exhibit a J-curve, which is a representation of the early losses followed by further capital gains. From January 2000 through December 2010, the Cambridge Associates Private Equity Index outperformed the Cambridge Associates Venture Capital Index and displayed a lower volatility, with an annualized arithmetic mean of 9,8% VS -0,8%.
|The key choice of Private Equity Firms
In contrast to traditional investment, the greatest part of private equity’s alpha comes from manager rather than asset or sector allocation. Indeed, a significant discrepancy exists between the top and last quartiles, which is also characterized by a certain resilience. Since current investors want to roll their top funds, there is a limited access to top managers.
Kohlberg Kravis Roberts & Co (KKR) is an example of top LBO private equity firm, which was created in 1976 and became famous when the firm bought RJR Nabisco Inc., a food conglomerate, for $31 billion in 1989.
|iShares Listed Private Equity – ETF (IDPE LN)
The iShares Listed Private Equity UCITS ETF is an ETF that tracks the S&P Listed Private Equity Index, which allows exposure to the preeminent publicly-listed private equity firms, and caps at 20% the Master Limited Partnerships (MLP) weight to avoid a sectorial bias (energy skewed).
Major countries weightings: United States (54,2%), United Kingdom (13,8%) and Canada (12%).
ETF’s top holdings : ICS (9,5%), Blackstone (7,8%), Brookfield (7,1%) and KKR (7,1%).
This ETF is listed on the London Stock Exchange.
|Sources: S&P, Bloomberg, CAIA Association, Cambridge Associates, iShares, Powershares|
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