This week we want to outline the investment case for making an allocation to Private Equity in client portfolios.
Over the past four years, we have invested in Private Credit and Private Real Estate markets but have avoided Private Equity based on our view that publicly traded stocks would outperform their private counterparts.
That has played out as expected. Private Equity valuations having fallen 22% over that period with returns having been generally flat since 2021. In contrast, public stock valuations have increased by almost 38% with the MSCI World Index returning 10% annualized in the same period.
Now we think that Private Equity has become more attractive than public stocks at current valuations. We plan to add Private Equity positions in our Aggressive Growth, Growth and Growth with Income model portfolios for Accredited Investors.
What is Private Equity
At its core, Private Equity is investing in the ownership of non-publicly traded companies. This is usually accomplished by investing in a fund designed to hold private company stock. The Private Equity market is pretty large (nearly $20 Trillion) and has grown substantially over the last 20 years as more companies choose to remain private instead selling their stock to the public on an exchange.
Private Equity is a term that encompasses several unique investment strategies including:
- Venture capital — Provides capital to new or growing businesses with perceived long-term growth potential.
- Buyout — Invests in established companies, often with the intention of improving operations and/or financials. These investments often involve the use of leverage.
- Growth equity — Provides financing to established and mature companies in exchange for equity (usually a minority stake) to help scale, expand into new markets, and/or improve operations.
Risk and Return
In general, Private Equity allocations, when managed properly, reduce portfolio risk while increasing overall returns.
Graph below is from Blackstone.
Since the Global Financial Crisis, Private Equity has returned 14% annualized with 10% volatility versus 7% annualized returns with 18% volatility for the Global Stock Market.
Private Equity also enjoys a lower correlation of return to the public stock market with a beta of just 0.7. This has allowed the asset class to outperform public stocks during crisis events.
Cambridge Associates recently published their target Net IRRs for Private Equity over the coming years.
We think these estimates are too high and would estimate returns on the low end of these ranges. However, we think that an allocation to Private Equity at today’s valuation levels will allow us to increase overall returns and reduce portfolio risk.
Allocation Details
We have decided to get our Private Equity exposure through funds managed by StepStone Group.
StepStone is the largest allocator to Private Equity in the world and oversees $682 Billion in private market assets. We believe that we’ll benefit in the following ways by using their funds:
Access to the top private equity opportunities regardless of sponsor
StepStone has access to the premier Private Equity Managers. Historically, access to the best managers has had an enormous outcome on returns. This is much less important in other asset classes as show in the graph below.
Increased levels of diversification
The firm will allow us to participate in a fund that holds investments in over 3,000 unique private companies across geographies and industries.
Reduced costs
Due to their large scale, StepStone receives significantly reduced fees when investing in Private Equity funds and avoids any sponsor related costs when participating as a Co-Investor directly in the underlying companies. StepStone is targeting up to 50% of their fund in Co-Investment opportunities.
Increased liquidity
As you can imagine, Private Equity is a lot less liquid that public stocks. Most institutional investors lock-up their money for up to 10 years when investing in Private Equity.
StepStone operates a fund that will provide quarterly liquidity for our clients. This will be similar to our other investments in Private Credit and Real Estate. If too many investors request redemptions in any one quarter, then the fund will be able to limit outflows (2.5-5% depending on the fund) to prevent a “run on the bank” scenario.
Custodied at Schwab
The StepStone funds will be held in each of our clients’ Schwab accounts which will aid in monitoring the investment and reporting performance. In addition to being on the Schwab platform, the funds will issue 1099s instead of K1s for tax purposes.
This investment will require each participating client to DocuSign subscription documents just like for the Private Credit and Real Estate holdings. As you can imagine, it is an enormous amount of work for us to facilitate this type of investment for our clients, but we believe that it will add considerable value to the portfolios.
If you have any questions about this investment, please reach out to us.
