- Private equity is seeing record inflows from institutional investors and family offices keen for higher returns outside of the public markets.
- Investors should be cautious that the opacity of private equity, which helps with returns, is a double-edged sword and lends itself well to price manipulation.
In quantum mechanics, Schrödinger’s cat is a thought experiment that illustrates a paradox of quantum superposition.
In the thought experiment, a hypothetical cat may be considered simultaneously both alive and dead as a result of its fate being linked to a random subatomic event that may or may not occur, and its state is only confirmed when the observer looks at the cat.
Which may be why private equity is seeing a resurgence of late.
Investors, perhaps weary from observing their portfolios of listed and published securities are increasingly looking to more opaque vehicles such as private equity, where there is only finality of price during liquidity events.
And that may explain why money managers at family offices managing vast fortunes for wealthy individuals have increased their allocation to private equity from about 15% in 2019 to a whopping 20% last year, the largest gain for any asset class.
As a family office manager, you can’t be fired for poor performance since that performance hasn’t been crystalized yet.
And a report by Swiss bank UBS, suggests that many more family offices plan to keep putting money into private equity.
The UBS report, based on a survey of some 200 family offices that each manage more than US$2 billion on average comes despite worries that tighter monetary policy will cool the economy and expose weaker private equity firms, especially heavily leveraged ones.
Despite these risks, many family offices appear to be confident in private equity’s ability to deliver superior returns because of tighter due diligence and privileged relationships with top managers that have the inside track on exclusive deals.
Public markets have continued to disappoint since central banks started tightening and understandably institutional money, from pension funds to large asset managers, are having to look elsewhere for returns.
Drawn by the promise of higher returns and as potential inflation hedges, a McKinsey report suggests that private equity has grown to manage over US$6 trillion.
Much of this reallocation of resources to private equity has come at the cost of bond exposure, which has seen a steady decline.
Nevertheless, investing in private equity can be a tricky business, especially as the rush of new money and players into the space, at a time when dealmakers are waiting to deploy a record cash pile from the pandemic, could see more investors chasing fewer quality deals.
And private equity firms may be tempted (some are already doing so) to “wash trade” companies amongst themselves to gin up their valuations and attract higher fees.