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Private Equity Returns to Remain Attractive, Many Routes Open

Tom Burroughes, Deputy Editor, London, 2 July 2008

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Private equity returns can be attractive, but for wealth managers, getting in the queue when institutional funds have huge sums to allocate is not always simple.

Private equity has not been unscathed by the turmoil in credit markets but for many high net worth investors, the long-term payoffs from this asset class are still attractive, industry figures say.

European private equity firms notched up average returns, after fees, of 11.8 per cent in 2007, according to data recently released by Thomson Reuters. That figure beat the 9.04 per cent total returns – adding dividends to capital growth – of the MSCI World Index of developed countries’ shares over the same year. While private equity and listed stocks are not directly comparable, the difference is still pretty impressive.

No investor wants to miss out on superior returns and for that reason, the arrival of huge sovereign wealth funds, armed with billions of dollars to be put to work, could be a problem for private banks if they find themselves pushed towards the back of the queue.

However, private bankers insist that although large pension funds, SWFs and other large institutional investors have the muscle to win some of the best seats at the table, they are by no means excluded, Paul Sarosy, head of investment solutions at the private banking arm of Credit Suisse, told WealthBriefing recently.

“The long term partnership that a bank has with private equity houses has a bearing on allocations made available. If you are a small house just entering the private equity market, you will find yourself in a less than favourable position,” he said.

But as he goes on to add: “If you have been doing it [private equity] for a long time and have those relationships with private equity houses over the years and working closely with them, your allocation will naturally be more satisfactory.”

“There are ways of playing private equity: an organisation, such as Credit Suisse works very closely with private equity houses. We are working with such houses and co-investing with them. We have our own private equity capabilities in our asset management division. And third, a bank can act as a distributor of funds,” he said.

“The private equity houses we are involved with are in the business for the long haul and we have a long standing relationship with them.”

And Mr Sarosy argues that while this asset class may have lost a bit of shine recently, there is every reason why private banks should want to build and retain close links to promising private equity firms. “I would not expect to see the very high returns of the late 90s or early parts of this decade, but I would still expect them to be double-digit.”

A number of wealth managers can solve the access issue by being members of large bank conglomerates that have their own private equity operations, such as HSBC and Morgan Stanley, for example. For the smaller private banks and wealth managers, access is often more easily handled through vehicles such as listed funds.

Exchange listed funds are now established features of the private equity market. There are dozens of these vehicles in London, New York, Amsterdam and other centres. Listed UK-based funds, such as 3i, F&C Private Equity Trust and SVG Capital, for example, can provide investors with access by simply purchasing their shares. The smaller private banks, such as Arbuthnot Latham, for example, use such funds as part of how they allocate to private equity.

Getting an idea of how well such funds perform is becoming easier: the LPX 50 Index, compiled by LPX, a Swiss company, tracks the 50 largest listed private equity vehicles in the world, showing their share price total returns. Such yardsticks make it increasingly easy for investors to figure out if they are getting value for money. The LPX 50 funds, for example, together have a total market value of about €90 billion ($142.3 billion). Even so, this is a small fraction of the industry as a whole. The unlisted private equity sector is estimated to hold as much as €1.5 trillion of assets.

The listed route, while convenient, can carry drawbacks. As is the case with all listed, closed-end funds, their net asset value – the value of the fund’s assets minus its liabilities – can trade above or below the share price. When trusts trade at a substantial discount to NAV, the holder could be forced to surrender a substantial capital gain if the investor wants to sell at that point.

Even if investors have reservations about some listed funds, in the private equity sector as a whole, there is no shortage of available funds around. In fact, the number of funds seeking to raise money worldwide rose to 1,478 at the end of May this year, a rise of 13 per cent from January this year and up by 61 per cent from January last year. These funds are seeking total commitments of $844 billion. Funds that were closed in 2008 took an average of 14.2 months to do so, which is almost 50 per cent longer than in 2004, suggesting that would-be investors have more of a chance to get into funds.

LPX expects returns to remain in double-digits overall.  "On average, private equity returns are 11 to 12 per cent a year but there are huge differences in the different [private equity] styles," Michel Degosciu, director at LPX, told WealthBriefing.

"We definitely see (an) increasing interest [in all forms of private equity] but it is hard to break it down in terms of money from private banks and others. Lombard Odier are using our indices for internal risk measurement; we are used by pension funds and by private banks, such as Pictet," he added.

Even with the big beasts of the institutional investor world still looking to make investments in private equity, there is no reason why they should grab this asset class entirely to themselves. As far as private banks are concerned, there is plenty of room left.

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