Alternative investments
Alternative investments
Podcast
29.6.2023
Anyone looking for lucrative investment opportunities will hardly be able to avoid private equity. With a total term of ten to twelve years and an investment period of usually three to six years, these closed-end funds have generated more attractive returns in the past, especially compared to equities.
The concept: The fund invests in companies at various stages - from start-ups to established brands - and develops them profitably so that investors can expect distributions after just four to five years.
The special feature of the private equity sector is its illiquidity. By tying up capital over a longer period of time, it is resistant to "panic selling" and therefore has an increased crisis tolerance. As part ofalternative investments, it therefore serves primarily to stabilize the overall portfolio and protect it from volatility.
But caution is advised: If these investments entice you with a higher profit margin, this is also accompanied by an increased risk, as it only becomes clear over time whether the investment is worthwhile. In the end, those who are able to distinguish really high-quality funds from others will benefit. This is a challenge that often discourages investors from trying.
So how should a private equity fund be properly assessed and what should you look out for in order to make an informed decision? We would like to answer this question below. First of all, we look at the general organization, the management team and the intended strategy.
When we talk about fund managers, the term does not just describe a single person. Rather, there is a team behind every investment offer that is entrusted with its organization. In order to be able to make a reliable judgment about the quality of the fund, it is first of all these people responsible for it who need to be evaluated. The range between experienced and inexperienced providers is just as wide as that between domestic and international providers. Even the number of people involved can provide information, as larger teams initially indicate more expertise and experience.
The track record provides valuable information on how profitably the fund management has invested in the past and provides data on its track record. However, it should also be noted how long this provider has been active on the market.
It is not uncommon for new managers to quickly earn an excellent reputation and for older ones to seemingly outperform. This circumstance is known as "survivorship bias", as there is a selective view of success. Instead of focusing on a few achievements, it is more advisable to rely on established companies that have achieved consistent performance across different economic and capital market cycles.
The track record should not only reveal general milestones, but also the background to successful investments: Which strategies were pursued, which companies were favored? What exactly were the framework and market conditions like and how were challenges overcome? On the one hand, it is important to find out how efficient the fund management can be considered, and on the other, to what extent it is able to deal with a changing market.
Based on the track record, you should also scrutinize which people have made which investments. The rule of thumb is: the more broadly the performance is distributed, the better. Otherwise, a "key man risk" arises - the dependence of success on a single team member. If this person decides to leave the management team, this could have an impact on the performance of the entire fund. This is a risk that you as an investor should avoid, however unlikely it may be.
Once you have answered the first questions, focus on the company's structure and its members. Promising companies not only have a good track record, but also many years of shared history and a stable employee structure without too much fluctuation. The stability of the senior level also plays a role, as does the experience of everyone involved.
A tip: Since private equity funds have terms of several years, a conclusive succession plan should be in place, especially for older founders.
Finally, it is worth taking a look at the operational and capital market teams. These specialized employees focus on operational development in cooperation with the management teams, often take on board positions or sometimes join the management themselves. The capital market teams are responsible for the financial structures of the portfolio companies. For example, at the beginning of 2022, some established hedging - a method of hedging losses - for the interest of the fund's beneficiaries.
Private equity funds are so-called "blind pools". This means that the companies that are acquired are not yet known when the investors commit their capital. The fund management creates a completely new portfolio. The management should invest in companies with similar characteristics (e.g. similar sectors and company sizes). During the review, it should therefore consider whether the strategy of the predecessor fund should be continued.
If you want to determine the quality of a fund in the next step, first consider its investment thesis, taking the following aspects into account:
It is important to check whether the investment thesis is congruent with the expected successes. To do this, it is important to take a close look at regional and sectoral forecasts and examine whether these match those of the fund. For example, if you want to invest in an investment targeting American companies in the venture capital sector, familiarize yourself with their political and economic background and consider the extent to which the targeted increase in value makes sense.
Another factor that you should definitely consider when creating your portfolio is its diversification. In other words, once you have found suitable funds, make sure that your allocation is widely spread across different areas. The greater this diversification, the lower your risk of loss. Possible criteria are
Instead of investing the entire wealth in a single fund, it is more advisable to spread it across various assets and strategies from different established providers . If one of these investments generates lower returns, this can be compensated for by others that do not follow the same approach. Funds of funds can be a sensible investment option for investors here.
The distribution over the investment year, also known as vintage, goes hand in hand with that of the management. The success of an investment often depends on when it was subscribed - or more precisely: how the political and economic environment develops over the term. Investors and fund managers have little influence on this area, but the risk can be reduced by using several vintages.
Once you have reviewed your options in accordance with the above points, you will have familiarized yourself with the political and economic prospects of the countries whose companies the fund favours. Even if the portfolio and planning seem promising, make sure you are diversified here too. Internal country circumstances can rarely be predicted, so a larger target area will provide you with long-term protection.
Finally, there are two different types of fund in private equity that you can also use for diversified allocation. While primaries gradually build up a completely new portfolio, secondaries are funds of funds that acquire shares in already invested private equity funds from existing investors or, in cooperation with the primary fund managers, transfer parts of the portfolios into a new vehicle to give the manager more time to develop the portfolio companies.
Although the fund review factors appear conclusive at first, individual investors rarely receive the transparency that a targeted investigation requires. Equally, many do not know where exactly to start their search or how to find reliable offers. For these reasons, family offices are very popular. Thanks to their extensive networks and information from consultants, databases or managed client portfolios, they have in-depth knowledge of the market that is not available to individuals. As they also look after several clients and select the most lucrative providers for them, they have a more open relationship with fund managers who are hoping for a place in the aforementioned network.
As the family office is solely dependent on the satisfaction of its clients and is not bound by any other interests, it sets strict criteria for the assessment of potential funds and thus relieves investors of all the associated challenges.
In summary, when making a qualitative assessment of potentially attractive funds, it is advisable not only to look at the fund itself, but to create a holistic picture of all factors. It is important not to make any decisions based on sympathy, but to rely solely on the facts. If you are concerned that you do not have the expertise or the means to carry out a detailed assessment yourself, seek the support of specialized providers such as family offices.
At the end of the day, it's your wealth - so use all the options that lead you to a decision that you feel comfortable with in the long term.
Alternative investments
29.6.2023
Fabian Richter
Private equity funds have made a name for themselves in recent years thanks to their high returns - and the supply has increased accordingly. But how do you as an investor manage to distinguish profitable options from less lucrative ones? Here you can find out what you need to look out for in funds and managers in order to position your wealth securely.
Anyone looking for lucrative investment opportunities will hardly be able to avoid private equity. With a total term of ten to twelve years and an investment period of usually three to six years, these closed-end funds have generated more attractive returns in the past, especially compared to equities.
The concept: The fund invests in companies at various stages - from start-ups to established brands - and develops them profitably so that investors can expect distributions after just four to five years.
The special feature of the private equity sector is its illiquidity. By tying up capital over a longer period of time, it is resistant to "panic selling" and therefore has an increased crisis tolerance. As part ofalternative investments, it therefore serves primarily to stabilize the overall portfolio and protect it from volatility.
But caution is advised: If these investments entice you with a higher profit margin, this is also accompanied by an increased risk, as it only becomes clear over time whether the investment is worthwhile. In the end, those who are able to distinguish really high-quality funds from others will benefit. This is a challenge that often discourages investors from trying.
So how should a private equity fund be properly assessed and what should you look out for in order to make an informed decision? We would like to answer this question below. First of all, we look at the general organization, the management team and the intended strategy.
When we talk about fund managers, the term does not just describe a single person. Rather, there is a team behind every investment offer that is entrusted with its organization. In order to be able to make a reliable judgment about the quality of the fund, it is first of all these people responsible for it who need to be evaluated. The range between experienced and inexperienced providers is just as wide as that between domestic and international providers. Even the number of people involved can provide information, as larger teams initially indicate more expertise and experience.
The track record provides valuable information on how profitably the fund management has invested in the past and provides data on its track record. However, it should also be noted how long this provider has been active on the market.
It is not uncommon for new managers to quickly earn an excellent reputation and for older ones to seemingly outperform. This circumstance is known as "survivorship bias", as there is a selective view of success. Instead of focusing on a few achievements, it is more advisable to rely on established companies that have achieved consistent performance across different economic and capital market cycles.
The track record should not only reveal general milestones, but also the background to successful investments: Which strategies were pursued, which companies were favored? What exactly were the framework and market conditions like and how were challenges overcome? On the one hand, it is important to find out how efficient the fund management can be considered, and on the other, to what extent it is able to deal with a changing market.
Based on the track record, you should also scrutinize which people have made which investments. The rule of thumb is: the more broadly the performance is distributed, the better. Otherwise, a "key man risk" arises - the dependence of success on a single team member. If this person decides to leave the management team, this could have an impact on the performance of the entire fund. This is a risk that you as an investor should avoid, however unlikely it may be.
Once you have answered the first questions, focus on the company's structure and its members. Promising companies not only have a good track record, but also many years of shared history and a stable employee structure without too much fluctuation. The stability of the senior level also plays a role, as does the experience of everyone involved.
A tip: Since private equity funds have terms of several years, a conclusive succession plan should be in place, especially for older founders.
Finally, it is worth taking a look at the operational and capital market teams. These specialized employees focus on operational development in cooperation with the management teams, often take on board positions or sometimes join the management themselves. The capital market teams are responsible for the financial structures of the portfolio companies. For example, at the beginning of 2022, some established hedging - a method of hedging losses - for the interest of the fund's beneficiaries.
Private equity funds are so-called "blind pools". This means that the companies that are acquired are not yet known when the investors commit their capital. The fund management creates a completely new portfolio. The management should invest in companies with similar characteristics (e.g. similar sectors and company sizes). During the review, it should therefore consider whether the strategy of the predecessor fund should be continued.
If you want to determine the quality of a fund in the next step, first consider its investment thesis, taking the following aspects into account:
It is important to check whether the investment thesis is congruent with the expected successes. To do this, it is important to take a close look at regional and sectoral forecasts and examine whether these match those of the fund. For example, if you want to invest in an investment targeting American companies in the venture capital sector, familiarize yourself with their political and economic background and consider the extent to which the targeted increase in value makes sense.
Another factor that you should definitely consider when creating your portfolio is its diversification. In other words, once you have found suitable funds, make sure that your allocation is widely spread across different areas. The greater this diversification, the lower your risk of loss. Possible criteria are
Instead of investing the entire wealth in a single fund, it is more advisable to spread it across various assets and strategies from different established providers . If one of these investments generates lower returns, this can be compensated for by others that do not follow the same approach. Funds of funds can be a sensible investment option for investors here.
The distribution over the investment year, also known as vintage, goes hand in hand with that of the management. The success of an investment often depends on when it was subscribed - or more precisely: how the political and economic environment develops over the term. Investors and fund managers have little influence on this area, but the risk can be reduced by using several vintages.
Once you have reviewed your options in accordance with the above points, you will have familiarized yourself with the political and economic prospects of the countries whose companies the fund favours. Even if the portfolio and planning seem promising, make sure you are diversified here too. Internal country circumstances can rarely be predicted, so a larger target area will provide you with long-term protection.
Finally, there are two different types of fund in private equity that you can also use for diversified allocation. While primaries gradually build up a completely new portfolio, secondaries are funds of funds that acquire shares in already invested private equity funds from existing investors or, in cooperation with the primary fund managers, transfer parts of the portfolios into a new vehicle to give the manager more time to develop the portfolio companies.
Although the fund review factors appear conclusive at first, individual investors rarely receive the transparency that a targeted investigation requires. Equally, many do not know where exactly to start their search or how to find reliable offers. For these reasons, family offices are very popular. Thanks to their extensive networks and information from consultants, databases or managed client portfolios, they have in-depth knowledge of the market that is not available to individuals. As they also look after several clients and select the most lucrative providers for them, they have a more open relationship with fund managers who are hoping for a place in the aforementioned network.
As the family office is solely dependent on the satisfaction of its clients and is not bound by any other interests, it sets strict criteria for the assessment of potential funds and thus relieves investors of all the associated challenges.
In summary, when making a qualitative assessment of potentially attractive funds, it is advisable not only to look at the fund itself, but to create a holistic picture of all factors. It is important not to make any decisions based on sympathy, but to rely solely on the facts. If you are concerned that you do not have the expertise or the means to carry out a detailed assessment yourself, seek the support of specialized providers such as family offices.
At the end of the day, it's your wealth - so use all the options that lead you to a decision that you feel comfortable with in the long term.
About the author
Fabian Richter
Fabian Richter works as an analyst in the Alternative Investments division and is responsible for the selection and review of investment managers.
Fabian Richter holds a Bachelor's degree in Business Administration from CBS, Cologne, and a Master's degree in Corporate Finance and Financial Engineering from the University of Hong Kong. Mr. Richter also holds the title of Chartered Financial Analyst (CFA®). In addition to his studies, Mr. Richter gained his first practical experience through numerous internships at private equity firms and asset managers.
He began his professional career at HQ Trust, the multi-family office of the Harald Quandt family. As an Associate Partner, he was most recently responsible for portfolio construction and manager selection in the areas of private equity and private debt.
