Private Equity for Individual Investors: Opportunities and Historical Returns
Are you curious about what private equity is and if you can invest in it as an individual investor? In this post, I will explore the pros and cons as well as the opportunities for retail investors and the historical returns of private equity.
What exactly is private equity?
Companies can either be public (listed on a public stock exchange) or privately held. Most of the well-known household names are listed on stock exchanges, where anyone can buy and sell stocks of the company. Privately held companies, on the other hand, are typically owned by a limited number of investors or families.
Usually, the term private equity refers to private equity companies that make their living from investing in non-listed (aka. privately held) companies. They may also seek to list or delist companies from public stock exchanges if they see a financial benefit in this. The private companies themselves, may either be listed or not.
Why is private equity interesting?
Historically the returns of private equity have been superior to the public stock market. For instance, between 2000 and 2020 the US Private Equity Index returned 10.5% annually, while the S&P 500 only returned 5.9% annually during the same period.
Higher returns are always interesting, but in many cases, they come with higher volatility (and thus risk). That seems to be the case for private equity as well, which means it's not applicable for short-term investing.
The less well-known opportunities
When a company is listed on a public stock exchange, it usually draws a lot of attention, and analysts will try to dissect the company to understand every little piece of the puzzle in order to come up with the most realistic valuation possible. Privately held companies, on the other hand, tend to go more under the radar, which means better investment opportunities may be hidden in this area.
How to invest in private equity
The problem with private equity is that these companies typically want investors with large amounts of money. Minimum investment amounts of $250,000 to millions of dollars are not uncommon for private equity companies. So, what are the opportunities for typical individual investors that don't operate with this kind of money?
Buy listed private equity companies
One approach is to buy some of the private equity companies that are publicly listed. These are just like any other stocks, and you can buy and sell the amount you want whenever you want. Here's a list of some of the largest and most popular private equity companies that are available as regular stocks (in no particular order):
- Blackstone Group (BX)
- KKR & Co. (KKR)
- EQT AB (EQT.ST)
- Partners Group Holding (PGHN.SW)
- 3i Group (III.L)
- The Carlyle Group (CG)
- Ares Management (ARES)
- Brookfield Asset Management (BAM)
- Apollo Global Management (APO)
- Man Group (EMG.L)
If you investigate the price charts of these companies, you will notice that their historical performance varies a lot, but some of them (e.g. BX, KKR, PGHN, and APO) have had quite a nice and somewhat steady growth over the years, which is what we want as long-term investors.
Buy an ETF
These days it has become a lot easier for smaller investors to diversify and get exposure to a long range of names at a low price, thanks to ETFs. Even for listed private equity, there are a few ETFs to choose from.
In the following, I will explore the iShares Listed Private Equity ETF (IPRV), which tracks the S&P Listed Private Equity Index (LPE). This ETF is available both for US and EU-based investors. Most of the companies in the list above are included in this ETF, which provides exposure to the 70-80 largest listed private equity companies in the world.
By comparing the performance of ETFs instead of indexes directly, we can get a sense of whether a potential premium is actually possible to capture with ETFs.
In the chart below I have compared the annual total returns of the iShares private equity ETF (IPRV) with a standard S&P 500 ETF (SPY), using the latter as a benchmark representing the public stock market over the last 10 years:
So, what can we draw from this comparison? A few things are worth noting:
- There's no general pattern as to how private equity performs compared to the public stock market
- As the correlation between private and public equity seems to be low, it may provide some diversification value to a portfolio of public stocks
- The best and worst years for private equity are far more extreme (more volatile) than for the public stocks
- During this period the SPY outperformed IPRV with an average of 13.7% vs. 10.3%
To sum up: Since 2013 an ETF that tracks the largest listed private equity companies has vastly underperformed a basic stock index, while also being more volatile (risky).
What happened to the superior performance?
Based on the history and reputation of private equity, I expected to see an outperformance. I'm not surprised to see that IPRV is more risky with more extreme ups and downs, but I certainly expected a better performance. Why did this happen? Is private equity not working anymore?
I see two primary reasons for this:
1. The problem with indirect investing
When we hear about private equity, we often hear about the returns achieved by private equity companies on their internal investments.
But we have to remember that listed private equity companies are just like any other stock. This means the valuation of the company is not just a result of its own return on investments. Its valuation can be driven up and down by a thousand other reasons. Even good companies with massive growth can become too expensive and the stocks need to come down even though the companies continue to thrive.
By investing in a listed private equity company, we are not directly investing in private equity itself, but in a company that deals with private equity. This can be compared to investing in a gold mining company. It will provide some sort of exposure to the price of gold, but it's an indirect investment and a lot of other parameters will go into the evaluation and price of the gold mining stock.
2. More competition for premiums
The other reason I believe is affecting these returns is one that seems to be ubiquitous when it comes to investment alphas these years. More and more people are getting access to information about complex investments and strategies, and at the same time, it has become easier than ever for anyone to invest in almost anything.
This causes an extended competition for the few remaining alphas in the investment world, as money flows to the assets where an alpha can (or could be) expected.
Private equity has a history of excess returns compared to the public stock market, but these premiums have not been visible over the last 10 years - at least not through the investment in listed private equity.
Would I consider adding listed private equity to my stock portfolio? Absolutely not. It may provide a small diversification benefit because of the low correlation with the public stock market, but the extreme volatility and the lackluster performance are definitely not worth it to me.