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While some high-profile failures can tend to hog the headlines, private equity is an asset class high net worth investors should keep in mind.
A small allocation has the potential to add a kicker to an investment portfolio. But it is important to do the research to identify good-quality fund managers.
In the traditional model, private equity is a way for investors to take ownership in an asset that is not listed on a public stock exchange.
In the past, private equity fund managers tended to pool assets in a closed-ended fund. This allowed fund managers to spread risk across the portfolio and time asset sales for the benefit of the asset and the fund.
But now, says Yasser El-Ansary, chief executive officer of the Australian Private Equity and Venture Capital Association, new ways of investing in private equity are emerging.
"There are now numerous private equity fund managers who are operating standalone deal-by-deal strategies. They are not running a closed-end fund strategy, which has historically been the common approach in private equity," says El-Ansary.
To invest in private equity you have to be prepared to do two things.
"You have to do the research and put in place a long-term strategy on a consistent basis for 10 years or more. Ideally, private equity should be part of a long-term growth strategy," he says.
There are now opportunities for high net worth individuals to be a part of those networks and to access private equity in a way that has not always been possible.
El-Ansary says what tends to happen in the deal-by-deal approach is that fund managers are in the market day-to-day looking at investment opportunities, curating a set of investments.
"Once they identify potential investment opportunities they will then go to a network of contacts, some of which will be high net worth individuals, as well as a multitude of others such as private offices and self-managed super funds.
"They look for investors to make a reasonably swift decision to commit capital to a target investment, in the knowledge they have a trusted working relationship with the fund manager. The investors understand the fund manager has gone through a comprehensive due diligence process on the opportunity in the lead-up to presenting it to them," he says.
El-Ansary's advice to high net worth investors is to develop a relationship with a network of professional fund managers in the market doing deal-by-deal strategies.
Another approach is to invest in mid-market private equity funds or fund-of-funds. There are also some listed private equity managers who are accessible through the public market.
"There's now much easier access to private equity than there has been historically," El-Ansary says.
However, private equity is a higher-risk investment and it is important for high net worth investors to assess whether this asset class suits them.
"Private equity investment does not suit all high net worth investors and not all high net worth investors have the risk appetite for private equity. It is not a clear-cut match," says Wallace Fan, principal of corporate advice firm Fidens Partners.
For instance, assets do not tend to be as liquid as share market investments. Investors in private equity funds are often asked to commit funds for up to 10 years before getting their capital back or receiving any real returns.
Investors who take the deal-by-deal approach can expect their funds to be locked away for three to five years.
"Investors need to have the ability to sustain limited to no cash flow [from the asset] in the short to mid term," he says.
Fan notes, nevertheless, high net worth investors with an entrepreneurial background may wish to have more of a direct connection with their investments and private equity can give them that feeling of control.
"It's important to balance life stages, objectives and risk tolerances to determine whether an allocation to private equity is appropriate," he says.
Fan says unless you are already actively involved in the industry the opportunity is in, it may be better to source investment opportunities via a fund manager that specialises in private equity.
It is also worth noting there are many different types of private equity. Assets can be segmented based on life stages, from early stage start-ups to opportunities to take an interest in large-scale, mature businesses. Investors can also invest in a theme.
Allegro is a private equity firm that invests in turnaround strategies for established businesses. Right Click is a private equity business that invests in technology start-ups looking for expansion capital.
Other private equity firms are focused on management buyouts from baby boomer business owners looking to exit their business. This is expected to be a huge growth area.
El-Ansary notes private equity, like all investments, carries a degree of risk.
"The best way to mitigate the risk factors that exist is not to cut corners and look for easy solutions to execute your strategy. You have to do the research. Speak with fund managers who have experience in this area," he says.
According to EL-Ansary, it is important to be comfortable with the manager you are placing your capital with and have conviction around the fund's strategy.
"That's the best way to minimise risk and give yourself the best shot possible at realising the significant after-fee return that will ultimately propel your wealth accumulation well beyond what the public markets can do," he says.
It is likely as baby boomers continue to exit their businesses and as private equity becomes more sophisticated in Australia, more opportunities will emerge for high net worth investors to play a part in this market.
The idea is to look for funds with a good track record of profitably buying and exiting businesses and allocate a sensible amount of the portfolio to these strategies.