As Institutional Investment in Private Equity Slows, Wealthy Investors Step In
Pension funds, insurers, and foundations have long looked to private markets to boost returns, but wealthy individuals are moving more assets into these sectors as fund managers make it easier for them to invest.
This shift is happening at a good time for private-equity funds as institutional investors hold back on funneling more capital into the sector, partly because of continuing economic uncertainty and rising rates, and partly because they are already fully invested. A big reason for their hesitance is the poor performance of public stocks and bonds in institutional portfolios last year allowed private equity holdings to grow as a percentage of overall assets.
These factors, combined with volatile markets and a cloudy outlook, led to a nearly 42% drop in new investments to global private-equity funds through the third quarter last year from 2021, according to Preqin, a London-based data and analysis firm focused on private markets. The firm expects another 2.6% drop this year.
Private wealth investors, therefore, present an opportunity for private-equity firms to raise financing at the same time more private investors—given poor returns and shrinking opportunities in public markets—are looking for alternatives.
“Generally, there is quite strong appetite across the spectrum from retail, private wealth, and family offices,” says Cameron Joyce, Preqin’s deputy head of research insights.
Private-equity investment managers have caught on. New York-based private markets investment manager Hamilton Lane, for instance, began to boost its private wealth business over the last three to five years, and has seen more wealthy investors take interest, says Steve Brennan, the firm’s head of private wealth solutions.
While institutional investors tend to invest between 30% to 50% of their portfolios in private markets—mostly in private equity—wealthy investors either don’t invest anything, or if they do, it’s been less than 5%, Brennan says.
According to Hamilton Lane, only 29% of high-net-worth investors invest in private markets, but the firm expects that percentage to rise to 46% by 2024.
These investors are recognizing that private-equity returns generally are higher than in public markets, as the number of public companies—meaning the number of opportunities to invest in public markets—continues to fall.
Also, firms such as Hamilton Lane are making the private markets more accessible, by offering investments in more investor-friendly structures with lower minimum thresholds. In addition, intermediary platforms have cropped up to make it easier for private-equity firms to get new investors, according to Preqin.
Penta recently spoke with Brennan about Hamilton Lane’s approach, and with Joyce about current dynamics in the market.
The Case for Investing
The global private-equity market isn’t immune from the challenges posed by rocketing inflation, rising rates, and the war in Ukraine, factors that are likely to still drag down performance, deal making, and drawing in new investors, according to Preqin.
From 2021 to 2027, Preqin forecasts global private-equity strategies will post annualized returns of 13.5%, down from 15.4% from 2015 to 2021. Even with that forecasted drop, Brennan argues, “the last thing you want to do is be out of the market at any given time.”
That’s because private equity has historically delivered better returns on average than public stocks whether markets are good or bad, he says.
If public stocks are returning 15% a year or more, private equity may only deliver another 1% to 1.5% a year, on average, but when markets are negative or in single-digital territory—which many analysts forecast for 2023—private equity outperforms by 6% to 8% on average, Brennan says.
“It’s a good place to be in a market environment we are in right now, as long as you are focused on long term and not on short term and being overly sensitive to the volatility we’re seeing in the market today,” he says.
Investors in current funds do, however, face headwinds from higher interest rates—which will lead to lower long-term valuations on assets—and the sell-off in technology investments, Joyce says.
“That’s a concern for private equity overall because the weight of technology in deal flow has been increasing over time,” and is relatively high in comparison to public markets, he says. Those investments had propelled performance in recent years, but could bring it down now. Also, higher rates makes it more expensive for private-equity firms to finance deals, which is likely to hurt funds that invest in buyouts.
Those who are investing in funds that are launching this year or next may face a rosier outlook. In today’s markets, “it’s a lot easier for new deals to be done at lower valuations,” Joyce says, providing more room for them to rise in value and deliver a better performance.
A More Accessible Option
Traditional private-equity funds are prohibitively expensive and cumbersome for most individual investors, even wealthy ones. The minimum investment is typically between US$5 million and US$10 million, and firms require investors to keep this capital readily available until it’s needed to make an investment. That process can take three or four years. Once the investment is made, the fund can hold it for 10-12 years. On top of that, tax reporting requirements are complex.
Hamilton Lane, like many investment managers, now offers an “evergreen” U.S. fund developed through the 1940 Investment Company Act—the law that led to the creation of mutual funds—with a US$50,000 minimum. Investors in Hamilton Lane’s Private Asset Fund get exposure to a diversified portfolio of private-equity investments through direct investments in companies, made alongside traditional private-equity funds, and in so-called secondaries, which buy assets from existing private-equity funds and are a small but growing part of the landscape especially as institutional investors trim their holdings.
The firm also invests 10% to 12% of the fund’s assets into private credit, to provide returns and liquidity, Brennan says.
Individuals are fully invested from the first day in the fund, and have the option to sell once a quarter. The fund allows up to 5% of assets to be liquidated each quarter, or up to 20% a year, subject to approval by its board. Tax reporting is also simplified.
For the year through Nov. 30, 2022—the latest data available—the fund returned 14.86%, Brennan says. That compares with a 14.39% drop in the S&P 500 in the same period, according to Dow Jones Market Data.
Fees are somewhat lower for investing in these funds, although they are higher than most public market investments. Traditional private-equity firms typically charge a 2% management fee in addition to a performance fee of 20% on profits beyond a stated target; Hamilton Lane Private Assets charges a 1.5% management fee and a 12.5% performance fee. Investors pay an additional 25 to 75 basis points a year depending on where they buy the fund.
Hamilton Lane also gives investors access to traditional private-equity funds through so-called feeder funds that allow individuals to invest with a lower minimum. The “2-and-20” fee structure is the same, however. In these instances, the firm will work with an intermediary that administers the fund.
Another reason individual investors are turning to private equity is the advent of more intermediaries that work with individual investors directly for access to the sector, such as Berlin-based Moonfare (which also operates in the U.S.). There are also more companies today that connect private wealth managers to private markets firms, such as New York-based iCapital, Joyce of Preqin says.