Private equity performs well in volatile markets

PRIVATE equity may not appear as the kind of asset class that a retailer would invest directly in but it’s one of the outperforming investments amid volatile markets.

Access to this form of investment for the man on the street is restricted mainly because of the liquidity and capital involved.

That said, it is the best performing asset class, beating equities, bonds and other asset classes, based on a 10-year asset class risk-adjusted performance, according to founding partner of TPG Capital David Bonderman.

The US-based private equity firm manages over US$74bil worth of assets.

To put things into perspective, the annualised total returns for private equity stood at 12.6%, compared to real estate investment trust at 9.5%, emerging market equities at 8.5%, US equities at 8.4%, high yield bonds at 7.7%, high grade bonds at 6.7% and hedge funds at 5.3%.

The 72-year old veteran of the leading global private equity firm shares his insights on the world economy and private equity during the recent EPF Global Private Equity Summit 2015.

There is a growing demand for private equity as institutional investors plan to increase their allocation of the investment class.

The Employees Provident Fund allocates 2% of its total asset under management for private equity, mainly through fund of funds but it is also building its capabilities by co-investing with partners as well as taking on cautious direct investment in mature markets. Comparatively, institutional funds in developed markets invest between 5% and 8% of their AUM in private equity.

To understand private equity better, it is imperative to know these two widely used terms:

Limited partners are institutions or high net worth individuals who invest in the private equity fund.

General partners are the managers of the investments for the private equity fund.

Bonderman says private equity asset under management has ballooned from US$1.7 trillion 10 years back to some US$4 trillion today.

In fact, one of the challenges for limited partnerss is that there are too many funds and managers.

There are 183 general partners that raised funds worth US$331bil while the 20 biggest private equity firms raised 76 funds worth US$312bil since 2010.

The number of funds he mentions doesn’t take into account the grey area of co-investment, which grew tremendously over the years.

Other challenges faced by limited partners include: relevant benchmarking, gaining exposure to attractive areas of interest and allocation relative to target.

At the current low-interest rate environment, some private equity firms tend to borrow more. These funds risk getting hit at a late cycle, warns Bonderman.

“Some people borrow too much or pay too much at the height of a cycle.”

Valuations are high in the United States but that doesn’t mean there aren’t opportunities, he notes.

On investment decisions, he quips: “The truth is, everyone gets it wrong most of the time.”

As for the world economy, he says weak growth in China and the emerging market pose the biggest risk to the global economy in the next one year.

Notably, China makes up 20% of the world population and contributes 13% to the world’s economy.

The republic is also a substantial consumer of major commodities.

As a result, shockwaves from China’s slowdown would be felt by its regional trading partners whereas the developed markets would be largely immune.

In his words, “China is in a slump but reports of demise are exaggerated”.

A slowdown in the Asia powerhouse’s growth is expected but the chances of a hard landing is low.

Even at a slower growth rate, a lot of wealth is created at China’s current gross domestic product of US$11.1 trillion, which is almost ten times what is was in year 2000.

In the United States, recovery might not be as strong as hoped but better than thought.

Europe will be staggering upward but might not be as strong as anticipated.

“(There are) moderate gains by monetary policy (in the European Union) but structural reform is necessary for long-term progress.”

As for the emerging markets, situations are mixed as performance range from “not very good” to “awful” because many were hit by the plunge in commodity prices.

Globally, he expects weaker-than expected growth but notes that an “imminent collapse” is unlikely.