At a time of economic uncertainty in the wake of the health crisis, is allocating part of your assets to private equity investments an attractive proposition? With the right advice and an appropriate strategy, this type of investment continues to offer promising prospects, especially over the medium and long term.
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Faced with the Covid-19 crisis in 2020, the central banks reacted by adopting unprecedented accommodative monetary policies, thereby contributing to the acceleration of the economic recovery. However, in recent months we are clearly facing further deterioration in the macroeconomic environment due to high inflation, the subsequent rise in interest rates and geopolitical risks. These risks are already reflected in share prices on listed markets, while unlisted markets, which include private equity, are not immune.
Long reserved for institutional investors, there is now a trend towards a certain democratisation of alternative investments, such as private equity. This is attracting increasing numbers of individual investors who are keen to diversify their assets and improve their prospects for returns over the long term.
Allocating part of their assets to financing unlisted companies, whether start ups (venture capital), more developed and experiencing strong growth (growth stage), or at a more mature stage (leveraged buy out – LBO) has proved an attractive strategy for many investors over the last decade, buoyed, like other assets, by a low interest rate environment.
But in the current context, is it still as attractive for investors?
Varying your strategies for diversification
Today's situation is not comparable to that of the Covid era. "During the health crisis, some sectors, like technology, were seen as a safe haven. And the low interest rate environment drove a significant rise in the valuations of companies in these sectors. Today, it's obvious that this favourable trend was not sustainable,” says Jérôme Zahnen, Senior Investment Adviser, Product Specialist Private Equity at Banque de Luxembourg.
"At Banque de Luxembourg, a long-term approach is inherent in our investment decisions. We generally avoid positioning ourselves on 'trendy' short-term investment themes.” The current macroeconomic environment, dominated by inflation and almost certainly heading for recession, is a concern for investors in every asset class, including private equity. A cautious and selective approach is therefore still essential, especially in the short term.
Of the three private equity investment strategies, the risk to the investor is generally higher when investing in start-ups with venture capital than in the growth or leveraged buy-out (LBO) stages. "The key, in our view, is to ensure that the private equity portfolio is sufficiently diversified in terms of strategies, sectors, geographies and partners. In the past, we have tended to steer clear of the venture capital strategy, but we are not closing the door on it as opportunities may emerge in the coming years, particularly via companies that are developing products and services to meet the challenges of climate change, which is a subject we are integrating into our investment considerations.” ”
Choosing the right partner is crucial
In the universe of listed companies, as in that of unlisted companies, choosing the right fund is an essential element for success. But, in the private equity universe it is even more vital as performance among fund managers differs enormously. This is where the role of the investment adviser is crucial. "It is essential to carry out thorough due diligence on the target funds. At Banque de Luxembourg, we systematically meet the managers to challenge them on various technical aspects before investing. We also combine our analysis of the funds with a top-down approach, studying the macroeconomic situation in parallel," explains Jérôme Zahnen. This makes it possible to identify the right partners, experts in their field, who are in the best position to select the companies most likely to deliver an attractive performance over the long term.
Illiquidity, a constraint and an opportunity
Unlike listed assets, a private equity fund generally commits the investor for 10 years. Investments may be made over a period of 5 years. This allows fund managers to diversify their capital deployment and gives them some flexibility to adapt to the rapid changes we are seeing today.
Sound advice is also essential in assessing the proportion of assets to be devoted to private equity or other unlisted investments. “A particular feature of these assets is that they are illiquid. That means that the capital invested cannot be released from the investment fund whenever you need it. If you have short-term projects that require substantial liquidity, it is best not to allocate too much of your wealth to this type of asset," says the Banque de Luxembourg adviser.
Long-term trends remain unchanged
Despite many uncertainties in the short term, the trends for private equity remain favourable over the long term. One example is the contraction of the listed equity universe. On the one hand, fewer and fewer companies are going public (IPOs) and on the other hand, the number of private companies is increasing. While an IPO has advantages, nowadays it seems that unlisted companies stay unlisted longer, which means that most growth and value creation takes place in the private markets. Private equity is therefore becoming increasingly important in asset allocation in order to gain exposure to small and medium-sized companies and participate in their development.
Banque de Luxembourg's adviser considers that private equity is therefore well equipped to continue to perform, especially over the long term. For the strategy to pay off, however, you need to be positioned on secular trends such as digitalisation and sustainability. "Currently, private investors are significantly underinvested in private equity so allocating a larger portion of their wealth to this asset class offers an opportunity to improve their long-term return prospects and diversify their risk exposure," concludes Jérôme Zahnen.
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