Is now the right time to invest in private equity?
Source : Les Echos
Author: Marie-Eve Frénay
The stock market is faltering, the clouds are gathering over real estate... Could salvation lie in non-listed investments? New players, some of them aimed at the general public, have announced that they are opening up to private equity. Is now the right time to invest in private equity? Let's find out in three key questions.
Will private equity, i.e. the purchase of shares in an unlisted company, become as common an asset class as listed shares or real estate? New players are offering their more or less affluent customers the chance to invest in private equity. Such is the case with Yomoni. This pioneer in online ETF-based life insurance has added a unit of account to its retirement savings plan, allowing simultaneous exposure to several private equity funds managed by Altaroc, and accessible from as little as 10,000 euros.
This entry ticket may seem high for a mainstream player like Yomoni. However, historically, this asset class has been reserved for institutional investors, who contribute several million euros per transaction. What's more, "from the 1st quarter of 2023, private equity will be accessible as part of our life insurance offering, from as little as 1,000 euros", explained its Chairman, Sébastien d'Ornano, recently. Yomoni is not the only pure player in online savings to take an interest in this asset class. Caravel, whose shareholders include unlisted asset management company Audacia, also hopes to offer its customers a private equity fund, according to co-founder Olivier Rull.
In a more upmarket segment, with an entry ticket set at 100,000 euros, the Archinvest platform, which launched on October 3, aims to offer a complete range of funds covering all private equity strategies (LBO, infrastructure, growth, private debt, real estate), accessible to private clients through their wealth management advisor or family office.
1. How do you explain this rise?
These launches are made possible by an accommodating regulatory framework. "While less than 1% of financial savings are invested in private equity, the eligibility of certain vehicles for life insurance and retirement savings plans will accelerate its democratization, which is still in its infancy," says Charles Beigbeder, founding chairman ofAudacia. He refers to the contribution of the Macron law of 2015, which was completed by the Pacte law of 2019. The former enabled the introduction of venture capital mutual funds exposed to private equity into life insurance. The second abolished the exposure cap of 10% of contract assets.
However, this regulatory change already dates back three years. It alone cannot explain the current craze for private equity. It may also be due to the economic climate, linked to the withdrawal of the traditional providers of funds: institutional investors. "Until January, the market was very open. But with the uncertainty brought about by the war in Ukraine, the value of stock market assets plummeted, leading to an overweighting of non-listed assets in institutional allocations and thus temporarily reducing their appetite for the asset class," points out Pierre-Olivier Desplanches, co-founder of Archinvest. Private clients therefore bring diversification to the investor base of these funds.
But above all, the main argument put forward is financial. In an uncertain economic climate marked by inflation and sluggish stock markets, the promise of gains offered by private equity is prompting asset managers to talk more about it as a way of boosting portfolio returns and diversification. In a study published last June, the consulting firm EY reported that private equity generated an average annual return of 12.2% between 2007 and 2021, compared with 5.1% for the CAC 40 and 6.3% for real estate assets.
Behind this laudatory average lie wide disparities between operations. "The median annual private equity performance is around 13%, while the top quartile peaks at 20%," points out Emilie Loyer-Buttiaux, co-founder of Archinvest. To put it another way, "the performance gap between the industry median and the best funds is 50%", adds her partner.
This double-digit return also rewards the illiquidity of private equity. It's a long-term investment. To recover the full amount of capital paid in and pocket the capital gain, you generally have to wait around ten years. "Historically, private equity has performed well, but since investors are committing themselves to the long term, they are potentially depriving themselves of other opportunities," adds Michael Sfez, Chairman of asset manager Kermony Office.
In detail, this is often a case of partial illiquidity, as it does not prevent the manager from releasing part of the capital at a more or less fixed time during the life of the investment vehicle.
2. Is private equity immune to the ups and downs of the markets?
Are private equity and financial markets correlated? It all depends on when the fund was set up. "Private equity has time on its side, unlike the equity market. But the vintages that are now coming to an end will be released at a time when the economic activity of the companies making up these funds may be less good than it was a few months ago, which will potentially have an impact on valuations", analyzes Michael Sfez.
Conversely, funds launching in times of crisis benefit from lower valuations. "The vintages of 2005-2007 were not very good, whereas in 2008-2010 performance was much better", recalls the president of Kermony Office.
Rising prices, particularly for energy, are currently one of the main threats facing both listed and unlisted companies. However, the way in which net asset value is determined differs between these two asset classes, which can lead to them being confronted with the inflationary shock at different times. This is why, for Charles Beigbeder: "Private equity is a good solution for immunizing against inflation and supporting companies that, potentially, are responding to major climatic and technical challenges."
The hallmark of stock market investors is that they are always on the lookout for difficulties that could, in the near future, reduce a listed company's profitability. Indeed, fear of recession is one of the reasons why equity markets have stumbled despite fairly good half-year results. Private equity, on the other hand, values a company from date to date. In other words, as long as a portfolio company improves its margins and demonstrates its ability to adapt to changes in its sector, it is unlikely to be written down by its shareholders.
On the other hand, private equity in its current form, the leveraged buy-out (LBO) - based on the creation of a holding company that takes on debt, in part, to acquire shares in the target company - is exposed to the risk of rising interest rates. This increases the cost of the loan required to purchase the shares in unlisted companies. However, with rates having risen from 1% to 3% in recent months, the cost of debt remains lower than the internal rate of return (IRR) targeted in this type of package. According to Raphael Hassan, Head of Investor Relations at Oddo BHF Private Equity, at a webinar organized by wealth management platform Grisbee on October 13, this IRR is usually expected to be between 10% and 15% net annualized.
3. How to invest in private equity?
Given the risk inherent in this type of investment and its intrinsic illiquidity, private equity is a medium that is not suitable for all investors, even though it is becoming increasingly accessible. As you need to be prepared to lock in your money over the medium term, this argues in favor of exposure through a long-term investment vehicle, such as a retirement savings plan.
Michael Sfez recommends 10% to 15% in non-listed assets, with a long-term perspective, for investors with 2 million euros in financial assets who want to grow their portfolio. On the other hand, "if you're looking to preserve your savings, it's not suitable, and if you're looking for yield, you need to go for other asset classes that distribute, such as private debt", explains the president of Kermony Office.
On the other hand, whether you're a small investor or a very wealthy one, it's important to diversify your private equity allocation. In the case of the low-entry-ticket funds mentioned above, this diversification is a priori offered by the very nature of the support offered, in this case a FCPR itself invested in other private equity funds. You need to check the underlying assets in advance. But by construction, this can provide exposure to dozens of companies of varying sizes, across multiple sectors and geographical zones.
On the other hand, "investing in a single fund is very dangerous", stresses Michael Sfez. In addition to the risk of one of the fund's companies under-performing, thereby undermining the fund's overall performance, this investment also exposes the investor to the risk of the fund's management team making strategic errors. Investing in several funds also means betting on different management strategies.
Audacia, which is working on a fund of funds, is logically emphasizing the purchase of its own stock as a liquid vehicle for private equity exposure. Its stock market listing makes it easier to raise capital to seed its private equity funds. "Holding our own stock also enables us to benefit indirectly from carried interest, part of which accrues to Audacia." This is the portion of outperformance that accrues to the fund's management team when the fund achieves good financial results. But as with any share, you need to analyze the company's performance and prospects before buying.
