PE firms raise funds from institutional investors such as pension funds, insurance companies, endowments and high net worth individuals. Private equity firms use these funds along with borrowed money and their own commercial acumen to help build and invest in companies that have the potential for high growth. The sector has grown to $3.2 trillion and increasing proportions of the investment portfolios of pension funds and sovereign wealth funds are in PE.
Some of the reasons for investing in this class are:
Long term historical out performance. The long-term returns of private equity represent a premium to the performance of public equities.
True stock picking in a low inflation low growth environment.
Absolute returns. The need to provide for ageing populations has obliged many institutions to adopt a more absolute return orientated approach in order to meet future liabilities. PE managers are committed to deliver these absolute returns and their incentivisation structure of carried interest is highly geared towards achieving net cash returns to investors.
Portfolio diversification improves risk and volatility characteristics
Exposure to the smaller companies market
Access to legitimate inside information. A much greater depth of information on proposed company investments is available to PE managers. Equivalent information in the public markets could be considered ‘inside information’. By definition investors in public markets will know less about the companies in which they invest.
Ability to back entrepreneurs. The PE asset class offers the ability to gain investment exposure to the most entrepreneurial sectors of the economy.
Influence over management and flexibility of implementation. PE managers are actively involved in the deciding on the strategic direction of their companies
Leveraging off balance sheet. Buy out managers are able to make efficient use of leverage. They aim to organise each portfolio company funding in the most efficient way to make full use of different borrowing options from senior secured debt to mezzanine capital and high yield debt.
Comparative tax benefits. The returns from PE are treated as taxable capital gains. These rates are lower than income tax. In the recent budget the Chancellor announced that capital gains tax are to be lowered.