As hedge funds lose some of their cachet amid poor
performance and an overabundance of offerings, some financial advisers are
increasingly turning to private equity as a way to diversify clients’
portfolios. Much like hedge funds a decade ago, access to sought-after
private-equity funds, or direct participation in deals, is seen by some
high-net worth investors as a sign that they have arrived. For their advisers,
private equity is a key tool in building up portfolios’ alternative investment
allocations in a way that clients can easily understand.
In many instances, the clients are themselves owners of
businesses or high-ranking corporate executives with an understanding of how
business deals work. On average, performance by hedge funds has badly lagged
that of the stock market since the 2008-2009 financial crisis, as stocks have
soared and competition among hedge funds has grown more intense. Last month,
California’s huge public pension fund announced it was exiting all of its
hedge-fund investments, citing high costs, complexity and uncertainty about
returns.
Private-equity investments can be expensive, too, and aren’t
for everyone. Minimum investments can range into the millions, and that money
is typically locked up for years, often for a decade or longer. Depending on
the investment vehicle or the deal, the investors are usually required to be
accredited investors--individuals with annual income of more than $200,000 or a
net worth of more than $1 million, excluding a primary residence--and even
qualified purchasers, which are individuals with more than $5 million in
investments. And there’s always the risk an individual deal could wind up in
bankruptcy.
Another option is to use a fund of funds, which spreads
assets around to different underlying private-equity funds and managers, though
this comes with another layer of fees on top of the underlying manager fees.
Still, the access to private equity and diversification that
can come with a fund of funds can be worth the added cost, says James Shelton,
chief investment officer of Kanaly Trust in Houston, adding that the expected
return needs to be 400 to 500 basis points above a traditional stock index on
an after-fee basis for a private-equity fund of funds to be worthwhile. Kanaly,
which manages $2.1 billion, primarily uses funds of funds for its clients
interested in private equity, though the firm on occasion has made a direct
investment in a fund.
One such move was an investment in a large private-equity
fund that was providing capital to companies in the energy and infrastructure
industry. This resonated with the firm’s clients, many of whom live in Houston
and are familiar with the energy industry.
Another way advisers are tapping private equity for clients
has been through direct investments alongside larger firms or investors. At
Signature, the vast majority of its private-equity investments are in
private-equity funds. Signature has at times done side-by-side investments with
a private-equity investor.
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