The advent of private equity firms has long since been a trend of the 21st century, with these asset managers snapping up top talent from investment  banks, left, right and center, they are an undeniable powerhouse within the alternatives space that have managed to beat the street’s returns on a  consistent basis. The field of private equity and debt investing simply refers to all of the investing activities undertaken by firms that deal with the buying, holding and selling of privately-held corporations and their obligations, in some cases this can even extend to taking public companies private. Some asset managers specialize in this and only pursue returns within private opportunities, while others employ a mix, combining trading public markets and private deals within their investment strategy. This is the second entry of our series on alternatives (see previous article on gold and real estate here) and within this post we will highlight the private equity space as well as its investment opportunities within the economic landscape of today. 

Within the field of alternatives, many are familiar with the concept of a hedge fund, it is very similar to a private equity fund except for differences in the equities and securities they focus on; while they focus on liquid, public market opportunities, private equity funds deal primarily in illiquid markets, they also have different time horizons, with hedge funds taking shorter terms bets and PE funds the opposite. While these firms already have a very secretive and private air to them, the case is no different and even to a greater extent in the realm of private equity. Hedge funds are required to disclose certain holdings and are carefully monitored by the SEC, for private equity funds, the game is different. Their investable universe is vast and stretches across different asset classes including debt and equity. The way they maneuver; their entry and subsequent exit strategies are also different from hedge funds because of the nature of their markets. PE funds operate within illiquid markets. Yes, variety is in its fullest form for these investors, they can do everything from acquiring private schools, to investing in biotech startups as well as everything in between and it is because of this that a lot of the functions these funds perform are related to the deal itself. On that note, as a possible investor of these funds, it is important to know how they work. PE firms are largely split into two categories with one hand being funds that deal with mature companies that have consistent and predictable cash flows and the other being a different type known as a venture capital firm. Venture capital firms specialize in startups with little to no sales history and generate return by virtue of taking these companies to IPO or acquisition. Moreover, venture capital funds are at the smaller end of the spectrum and often provide the ‘smart money’ draw of consulting services to the firms they invest in. Larger private equity funds employ a range of methods to their deal flow, in some cases using leveraged buyouts to acquire firms and grow. 

A private equity firm can generate return from its investments through a number of avenues as well. The most direct of which is to sell their acquired companies for a multiple of what they were purchased for and another likely option is that they operate the company in the long term and withdraw their profit as shareholders to recoup their investment; in both cases they benefit from recapitalizing and taking every opportunity to increase the profit margin and overall profit numbers of these assets. The third route a PE firm may travel is that of what has become known as ‘vulture funds’. These companies will focus on buying distressed assets, such as a company whose sales are suffering, and generating their return through any course of action that allows them to squeeze profit out. Whether it be through selling an arm of the company or its patents and processes, these funds will do it all to garner a return, with a disregard for its overall well-being as a functioning business, hence the title, ‘vulture fund’. 

The alternative investment space is a diverse region of the investment landscape and the private equity world, which makes up a large portion of it, follows suit. Firms in this space are made and broken by the quality of their workforce. A PE firm is as engaged in deal making as it is in deal sourcing and it is because of this that they need to be exemplary within both arenas. As such, the best performers are often times individuals from investment banks that have backgrounds structuring deals and seeing them through; regardless, if allocating capital towards these funds, the bottom line is to understand that their job does not end at choosing the right investment, but a majority of the work is done through the process of acquisition, and sometimes the subsequent restructuring and exit. Correspondingly, before choosing a private equity firm to invest with, an allocator must ensure that they have full confidence within their investment team. Moreover, in this vast array of alternatives, private equity options can be an optimal investment vehicle that provide low correlation to the increasingly volatile and unpredictable public markets. Thank you for joining us and make sure to check back in a week for the next part of our alternatives series, this time focusing on the hedge fund industry.