Private equity - An integral part of the global economy

Private equity-backed companies are a vital part of the economy and a significant driver of economic growth. In France, for instance, 120 of the most promising startups are doubling their turnover every year, according to consultancy firm Roland Berger. By contrast, companies in the CAC index are growing at just 3% a year on average.

Almost ten million people in Europe worked in private equity-backed companies at the end of 2020 – more than the entire population of Austria, according to Invest Europe’s 2022 Private Equity at Work report [1]. Private equity portfolio companies created 2% more jobs on a net basis in 2020. Compare that to the entire European jobs market, which contracted 1.6% over the same 12-month period.

As Invest Europe points out in the report, private equity isn’t niche, rather it is a cornerstone of the European economy and an integral part of its society.

In the US, meanwhile, the private equity sector generated $1.4 trillion of GDP in 2020, or roughly 6.5% of overall output, according to a report from the American Investment Council and EY [2].

A building block for portfolios
Many investors, including family offices, are missing out on this growth potential. In part, this is because of private equity’s perceived lack of liquidity and barriers to entry. These characteristics mean investors often lump private equity assets in with a broader basket of alternative assets, such as hedge funds or structured products, says Edouard Nouvellon, founder of European financial consultancy Risk Return (you can read Nouvellon’s full report on the role of private equity in the family office portfolio by clicking here).

“Private equity forms the major part of the economic fabric of many developed countries,” Nouvellon says. “Therefore, it shouldn’t be viewed merely as an alternative asset, but rather a building block in the constitution of a portfolio – much like bonds.”

Nouvellon argues that the liquidity offered by listed shares often leads to a bias in their allocation, with the allocator forgetting that listed shares are only a subset of the broader equity asset class.

Accessing more of a company’s lifecycle
One reason to consider increasing allocations to private equity is the exposure they offer to companies at different stages of development and, therefore, the access they give to a greater spectrum of risk/reward profiles than would be possible in public markets.

Buyout funds, for instance, tend to focus on later-stage companies that are comparable to some listed small-cap businesses. Some funds, such as venture capital funds, focus on start-up or scale-up companies that could offer significant return potential – albeit with a greater risk of failure.

Growth funds sit somewhere in the middle. They can offer investors access to companies that already have a proven customer base and that are in expansion mode, often achieving double-digit EBITDA (earnings before interest, taxes, depreciation and amortisation) growth.

Growth equity fundraising hit a record $132 billion in 2021, according to McKinsey [3].

Private equity also gives investors access to more so-called pure play companies – organisations that are focused on one specific business line. This enables more targeted investment themes or sector exposure than listed equities, where companies tend to operate across several different business lines.

On top of all this, many companies are staying private for longer. Sometimes when companies do finally opt for a stock-market listing – particularly those involving smaller, profitable companies in niche sectors – it can be a signal that all the potential juice has already been squeezed out, says Nouvellon.

What about illiquidity?
There are, of course, risks to investing in private equity. But one that is often cited – that investors must give up liquidity by locking up capital for longer periods of time – is not clear cut. Some investor surveys have started to hint at the disutility of liquidity, in part because the ease of buying and selling listed equities can cause bouts of market volatility that private equity investors avoid. The assumption, therefore, that less liquidity brings more risk, is debatable, says Nouvellon.

“Private equity investors see the lack of liquidity as an additional utility factor,” he adds.

There are more options than ever for family offices and other wealthy individuals to access private equity markets through investment vehicles such as feeder funds. Therefore, the opportunity to increase strategic allocations to the asset class has never been easier.    
 

View the full report written by Edouard Nouvellon for Titanbay here.

[1] Invest Europe

[2] Investment Council

[3] McKinsey

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