How do you make money in an era of low inflation and converging international markets? It is a vexin...
How do you make money in an era of low inflation and converging international markets? It is a vexing question for many millions of private investors who have grown accustomed to double-digit stock market returns and who must now consider that these returns may sink below 10% for the first time in five years.
Private investors have accumulated more assets in a decade-long bull market than they know what to do with. The total wealth of high-net-worth individuals worldwide at the end of 1999 was estimated at close to $25.5 trillion by the Merrill Lynch/Gemini Consulting World Wealth report. Moreover, the number of high net worth individuals and the wealth they hold grew by more than 18% in 1999, compared with just 12% a year earlier.
These investors realise that alternative investments, private equity, hedge funds and other unlisted vehicles, provide diversification and have generated high returns for institutional and private investors alike. Indeed, returns from private equity have historically exceeded returns from conventional investments in the public markets.
Private equity is an umbrella term for an investment that takes direct equity stakes in companies that are often private (ie not publicly traded.) The term private equity covers a number of aspects of this investment process, but, broadly speaking, it can take the form of either venture capital (investment at an early stage in a company's life) or buy-outs/buy-ins (investments that apply to structural changes at established businesses.)
What all these transactions have in common is a vision of change: private equity investors see that a business will benefit from a different capital structure or new management. After a period of re-adjustment, the business will be either listed or sold to another company. Thus, private equity investments are, by nature, transitory.
The private equity market as we know it today emerged in the US, fuelled by demand from investors prepared to take higher risks to gain access to high-growth companies whose performance was considered too volatile for the mainstream stock market.
Supply was provided both by young companies seeking to stimulate their growth and by established companies looking to sell business divisions that were either unprofitable or peripheral to their central strategy.
The UK private equity market opened up in the 1980s and is now the most developed after the US. Continental Europe developed later but is poised for rapid growth thanks to the ongoing restructuring of European business and industry. The Asia-Pacific region is relatively well-served by private equity funds, although the pool of available capital is small compared with western Europe. Latin America, too is emerging as a market in its own right.
Over the past 15 years, funds worldwide that make private equity investments in companies have prospered as technology and globalisation have spurred the restructuring of older industries and entrepreneurial activity has taken root beyond the borders of the US. When stock markets are strong and corporate profits are buoyant, private equity funds find plenty of opportunities to realise gains.
Historically, however, traditional private equity funds have been almost inaccessible to the private investor. Because the equity stakes that private equity funds take in companies are often illiquid, unlike quoted companies, their shares are not easily traded, private equity investments have tended to be made through a limited partnership structure, set up by a specialist asset manager.
These limited partnerships usually require investors to commit $5m or more for a period of up to 10 years. What's more, funds raised through this structure often invest in a particular industry sector or region. So an investor would have to make a number of investments in order to generate a portfolio with holdings that offer any sort of diversification. In a market sector that is potentially high risk, lack of portfolio diversification can increase the risk, as it would in a traditional equity portfolio.
The high investment threshold, coupled with the difficulties of creating a diversified portfolio, have kept all but very high net worth individuals or larger financial institutions out of the market for private equity.
Funding an answer
However, more and more smaller institutions and private investors believe they have found the answer to this dilemma in funds of funds, or multi-manager funds as they are more commonly known in much of Europe.
These funds are investment vehicles that pool sums of money in order to invest in various private equity funds and other unlisted, alternative types of investment. Because they provide access to an alternative asset class that can enhance returns while reducing the volatility of portfolios, funds of funds can offer investors both the better risk profile and the stable long-term returns they broadly seek.
They come in essentially two forms: limited partnerships offered by banks and specialist firms and that still require a minimum investment and have a fixed investment term, and listed private equity fund of funds or investment trusts that have no minimum investment requirements at all.
Listed fund of funds combine diversification across multiple fund managers, industries, markets and investment strategies with liquidity. Because they are listed, investors can trade their shares.
In most respects, listed funds of funds offer the ideal gateway for smaller, individual investors to enter an exciting and lucrative market.
There are six listed private equity funds of funds in Europe offering investors both liquidity (because they are listed) and diversification across multiple industries, markets and investment styles. Tw
Launched November 2018
£15m group claim
'Nothing particularly different' - expert
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