IPO fever has led to big profits for buyout firms, but family offices shouldn't be fooled by the success stories
Many people wouldn’t dream of investing in the stock markets at the moment because they look frothy, to say the least. But by putting their money into long-term investments, investors might be unwittingly making a play on equities anyway.
Many family offices are increasing their private equity exposure right now because they are tempted by direct deals over investing with banks. That makes sense. Private equity firms offer expertise in things like due-diligence and relationships with placement agents and other investors which makes deals more appealing. As private equity touts itself as long-termist, it should be a perfect fit for a family office’s illiquid portfolio.
But things are not as they seem with private equity. In reality, its “long-term” investment horizon is five-to-seven years. That might be an eternity to a high-frequency trader, but not necessarily to a business family. However, the real problem with private equity is that its appeal is an artefact of high equities prices.
In the past year many private equity-owned firms have had IPOs, which means the firms can point to good profits. A recent report by EY said that there were 264 private equity or venture capital-backed IPOs in the first nine months of the year, making it the best year since 2001. In total, these IPOs raised $105.3bn and returns were 19% year-on-year. Families are unsurprisingly tempted by these numbers.
But the whole reason that IPO fever is striking now is that markets are high, firms can get a good price, and everyone is rushing to get these deals off their books before the bubble bursts. What private equity’s cheerleaders don’t mention is that until the recent IPO fever they had been sitting on some of these firms since 2005, and their investors are desperate to get some money back.
And, even more pertinently, private equity firms currently have $1.19 trillion of dry powder - uninvested capital - according to Prequin, an industry data-provider. So any new money they raise probably won’t go to work immediately, and there is a lot of competition for the best deals. Prices are sure to be inflated.
The problem with private equity is that not all years are good years. As Philip Higson, vice chairman UBS Global Family Office Group puts it: “Recent returns are good, but the caveat is that the dispersion of the return from private equity is really wide.”
True, private equity doesn’t rely entirely on IPOs because exits can also come from trade sales or secondary buy-outs. But anybody investing in private equity now is looking for the big IPO bucks, which depends on stock markets remaining buoyant.
All this suggests that an investment in private equity is a proxy investment in equities.