Investing in private equity can bring you very nice returns – provided you know what you are getting into and can muster the relevant expertise to do so responsibly.
As the old adage goes, there is no such thing as a free lunch in finance. If you want higher returns, you almost always need to take on more risk.
When you invest in private equity, you are in for the long term – usually 10 years. So if liquidity is high on your priority list, it may not be for you.
In addition, you must do it through experts who know private markets. In fact, the top performers in the private markets can generate returns of 15% to 30% above the manager’s median.
This is where Credit Suisse comes in.
“We are fortunate to work with a number of global managers who have the expertise in this area and are often specialists in specific areas,” said Stephen Cabot, executive director of wealth management at Credit Suisse.
“So if they’re a growth-oriented organization, they’re going to understand how to target the markets they’re investing in, the management they can put in place for that opportunity, and how to monetize that.”
In this article, Cabot discusses the intricacies of private markets investing, how Credit Suisse selects its investment managers, and also the sectors and companies that set it apart.
How do Credit Suisse clients use private equity investments?
Stephen Cabot: Private equity is an important part of our clients’ allocations. We talk to clients about starting with a 5% allocation in strategic asset allocation, but given the particular characteristics of private equity, i.e. its illiquidity, holding investments for 10 years, together with its capital call structure, this can be something , which you need to be pretty careful about managing. Because of these characteristics, some customers prefer not to have a large allotment. But on the other hand, we have clients who are very comfortable with the illiquidity and take more of an endowment style approach where they invest 20% or 30% in the private equity class.
The lure of private equity returns is obviously an attraction, but it needs to be measured against that illiquidity component to ensure it makes sense.
What are the different ways investors can access private equity through Credit Suisse?
We have a number of ways clients can access private equity and our core offering is a portfolio of private equity funds that we put together. We like to treat that as a core offering that customers have. We maintain diversification by manager, by region, by strategy and by vintage. We encourage our customers to take advantage of this core offering in an annual phased process as we launch them.
That was the first way. There are occasions when we focus on specific strategies or sub-sectors that individual managers will bring to the client base. We also have co-investment opportunities. These usually come with the opportunity to work with great managers and there may be some opportunities to invest alongside them. However, they tend to encourage clients to do their own due diligence, so again, this isn’t necessarily for everyone.
Finally, we have so-called semi-liquid solutions where clients can access a diversified solution of private equity opportunities. And they’re going to handle smaller allocations and that’s going to work quite well for our clients.
How do you rate private companies compared to public companies?
The key to identifying an opportunity is determining what you should pay for the investment opportunity. There are vastly different skills to apply this to a private market in the public market and we are fortunate to work with a few global managers who have the expertise in this area and are often specialists in specific areas. So if they’re a growth-oriented company, they’ll understand how to target the markets they’re investing in, the management they can put in place for that opportunity, and how to monetize that. These are different skills than in the public markets, where most companies have the same information available and everyone evaluates it.
In the private market, it’s a little more nuanced about what’s available and how to value it. So it requires special skills and that’s why we’re happy to work with some great managers.
How do you select private equity fund managers?
The selection of managers in private equity is crucial. If we look at the listed and public markets, and the liquid bond and equity markets, the average manager produces a return, and with the top five percentiles, you get a 2% to 5% return from overperforming stocks and bonds. You definitely want to be invested in these managers where you can.
In the private markets, which are expanding enormously, where the spread of returns is much wider.
The top performers in the private markets can generate returns of 15% to 30% above the manager’s median.
Aligning with some of these top quartile managers is extremely useful and beneficial.
There is also a sustained return that comes from these managers where they continue to be top performers. Aligning with them is vital and we are fortunate that the Credit Suisse private equity program has been in place for several years. We have some key colleagues who have built networks and connections that have opened up these opportunities and we are able to invest alongside some of these world class companies.
Which sectors are more suitable for private equity?
If we look at the private equity markets today, technology and healthcare are two areas that stand out.
The challenge in technology is that it is such a broad description of what is available out there because every industry is now using technology for efficiency and advancement. So it becomes really important to focus on those that have a specialty, the fractional allocations, that they invest in. That will always be an opportunity in the current environment we are in.
Healthcare is another area where there are tremendous reasons for many investments and opportunities, and they need capital to develop these ideas.
However, as mentioned, it is the full range of opportunities available in the public markets. Where we see companies not being listed as quickly and staying private longer. In terms of sectors, there are opportunities across the spectrum, it’s just a matter of buying them at the right price.
Do private equity investments typically focus on earlier or later stages of a company’s life cycle?
There are different types of private equity that target different segments. We can start with venture capital, which is very early. We can move to growth, which comes a little later, and buyouts probably later again, and we have solutions in all of those areas. The returns can be much higher in the company and create some more headlines. However, there may also be a major downside to investing there. The risk is greater and the probability of failure is higher. Again, diversification is key, ensuring you get some exposure to each of them and only weighting these correctly, in accordance with your risk profile, is really key to positioning.
Can you give two examples of companies you have invested in?
It is important that the opportunities are offered to Credit Suisse clients in different ways. The first thing I’m going to talk about is the co-investment opportunity. It was at McGraw Hill Education. So this is a group responsible for publishing educational textbooks and so on. They were in private equity hands but were looking for an M&A opportunity. With this, they really wanted to propel the company into a more digital delivery of educational resources. They came into the market looking for additional capital. Our clients were able to assess that and allocate some funds. It was hugely successful, it coincided with the pandemic bringing about a huge shift in education and many more shifts to online education opportunities. Since then they have been able to take advantage of this opportunity and it has been held for about 12 months. It was a two and a half to three times multiple. So, a very successful opportunity there. The other area where we have some very interesting opportunities that our customers are really interested in is climate innovation.
Here we work with a number of venture capital firms dedicated to climate protection. Credit Suisse believes that it is far better to invest these funds in the private market to create change where we can achieve the creation of new technologies and new processes that will have a real impact. In the public markets, we can choose not to invest in coal or oil companies, but someone else will invest in this opportunity for us and there can still be money to be made. If we can help allocate capital to these new companies, they will drive these new technologies, and that’s a really interesting opportunity. We’re relatively new to this space, but there’s a tremendous amount of tailwind. The energy problem in Europe obviously brings this to the fore. We got the states to sign some new laws to encourage this, and our customers asked for it and are now being given the opportunity to drive change around the world.
What tips do you have for private equity?
I think one of the biggest challenges for private equity investors is understanding the nature of the J-curve, which is the initial phase in which investments are made. Valuations generally do not improve over this period and there may be some costs to manage the funds and take opportunities where we want them to be. This is where you can suffer that drawdown. So for the first year or two it can be a difficult challenge to come in groups. If we can see across the valley and look ahead, great opportunities open up, but those first few years can be very challenging. Without the ability to sell in a public market, certainly at some sort of market price, you don’t want to be put in a situation where you are forced to sell. Therefore, a long-term approach, as well as comfort and understanding of the J-curve, are crucial.
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