In today’s markets, illiquid investments such as private equity can significantly enhance returns in clients’ portfolios. “The premium and the cost for liquidity have never been higher,” says Rhian Horgan, international head of alternatives at JP Morgan Private Bank.
“In an environment where cash is yielding less than 1 per cent and equity markets remain volatile, significant yield enhancements have been provided by the private credit market. Also, private equities are continuing to outperform public equities,” she says. “In the private equity space we are looking to earn between 5 and 10 per cent per year on a compounded basis in excess of what you can earn from public markets.”
Illiquidity in private equity, where investors’ money is generally locked in for 10 years or more, is always going to be a concern. “The question for clients is how much illiquidity they can tolerate and what the cost of not tolerating any illiquidity is. When cash rates are very low, there is a huge cost for liquidity. Investors really have to think about how much liquidity they need in their portfolio.”
Through private equity, it is possible to gain exposure to opportunities not accessible through public markets, explains Ms Horgan, with emerging markets including some Asian countries and also Brazil, offering particularly good potential.
“We are very optimistic about the opportunities in private equity in Brazil,” she says. “We are fundamentally bullish on Brazil, where we have seen a decade of prosperity and stability.”
However, 50 per cent of its public market is comprised of eight stocks, which are mostly financials and a few large commodity players. “If you really want to get access to the domestic growth story in Brazil, you will have to do it through the private markets,” she says.
Private equity opportunities are also found in the technology sphere, which has proved to be a recession resistant sector. “Consumers were more likely to give up going out to eat than to give up on their mobile phones,” says Ms Horgan.
But there are tremendous changes happening, she explains. “There are a lot of winners and losers in the technology space, and there are many opportunities which aren’t very economically sensitive. A lot of interesting private companies haven’t gone public yet, so in order to be involved in some of these emerging technologies, you need to make private investments before the companies go public.”
Energy is another interesting sector, even more crucial in light of the Mena crisis and the world’s tightening of reins on nuclear power, provoked by the nuclear disaster at the Japanese Fukushima plant. “If you believe in the emerging market growth story, you can see how demand for energy is going to grow quite dramatically over the next 10 years,” says Ms Horgan.
“While there are certain sectors where there is strong supply growth, such as coal or gas, there are other places, in particular nuclear, which are much more restricted,”
A very high volume of M&A activity is taking place in the energy space, with more than 2,600 M&A deals globally during the last five years, of which the large majority, 2,300, have been small transactions worth less than $500m (€350m).
The fund of funds route
The traditional hurdle with private equity investing is the very high minimum threshold to get into funds: minimums are as low as $1m but they go as high as $25m, so a medium to high net worth investor, in order to get the appropriate diversification, will generally need to go through a fund of funds, rather than the direct fund route.
“Clients who are putting $10m to 20m to work in private equity have enough capital to build out diversified portfolios themselves, whereas if they put $2m or $3m into private equity, a fund of funds makes more sense,” says Ms Horgan.
Because of the illiquidity associated with these investments, and as many of them are private placements, there are strict regulations around what types of investors can invest in these strategies. Typically, clients need to be worth more than $5m, in order to be deemed to be eligible to invest.
One of the reasons why the entrance thresholds are so high is that private equity firms have historically been built around investment professionals or deal makers, rather than a team of client servicing professionals, explains Ms Horgan.
“Over time private equity firms have built up more people to interact with their limited partners (LPs) but the reality is that most of these managers have a lot more resources dedicated to investing than client servicing. That’s why you don’t tend to see them accepting investments typically less than $10m in their funds. In fact many managers have minimum investment size of $25m or more.”
In that sense, a partnership between managers and private banks creates good synergies. “We have great relationships with our clients, we do the due diligence on funds and then we provide the monitoring and the servicing of the investments that our clients make. That gives us the flexibility to then allow clients to invest at smaller bite sizes in these funds,” says Ms Horgan.
