iSTOX Academy: What Is Private Equity?

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Key takeaways

· Private equity (PE) gives investors exposure to companies that are privately owned and not listed on a stock exchange.
· Outside of iSTOX, the barriers to investing in private equity have been high, allowing only institutional and very high net worth investors access to this asset class's opportunities. iSTOX is changing this, however.
· Private equity has historically offered higher returns than publicly listed stocks. However, fees can also be higher, comparative performance figures are up for debate, and many have lock-in periods of up to 10 years. iSTOX, however, significantly reduces many of these limitations.

What is private equity?

Private equity offers investors an ownership stake in a rich range of companies that are held in private hands and are not tradable or available on the public stock exchanges. Outside of iSTOX, the asset class is generally only available to financial institutions and the very, very wealthy and well-connected. Investors can access private equity by investing directly into private companies or via private equity funds.

On average, private equity has generated higher returns versus public equity and fixed income over the past decade. According to research by Cambridge Associates and selected benchmarks, from March 2010 to March 2020, private equity returned 13.2% per year compared to 6.6% in public equities and 4.2% in fixed income securities. To put this into perspective, the implied compounded returns of PE over the last 10-year period was 246% versus 89% for public equity. In recent years, private markets have had significant momentum as global assets under management (“AUM”) grew by US$4 trillion in the past decade - an increase of 170%, while the number of active private equity (PE) firms has more than doubled. By the end of 2019, total AUM across markets hit an all-time high at US$6.5 trillion, according to McKinsey.

Who can invest in private equity investments?

Previously, only financial institutions and ultra-high net worth investors were able to invest in private equity because of the high minimum investment amounts required. These often run into millions of dollars. This, however, is starting to change thanks to iSTOX, which allow accredited investors to buy in for as little as S$10k.

What are the advantages of investing in private equity?

· It comes down to performance, performance, performance. Private equity investments can offer much higher rates of return than investments in publicly listed companies and other traditional asset classes. It is worth noting that the highest growth and return periods of many companies today occur before they are listed on the public markets.

· Investments in private equity can be far less volatile than public stocks and can be less subject to the ups and downs in investor sentiment because investors are locked in for many years.

· Good private equity managers have access to more opportunities to find companies that offer substantial upside potential. Publicly listed companies are extensively analysed, and performance is transparent to all, therefore undervalued companies are less common. As many potential investors do not follow private companies closely, there are more opportunities available.

What are the disadvantages?

· Performance figures for private companies are not subject to the same regulatory requirements as publicly listed companies. Thus it is more difficult to rely on the performance figures provided on private companies.

· Private equity investments can be riskier than public ones. There is a risk that the private equity manager doesn’t achieve the results necessary to add value to the company as planned. At worst, the company could fail and wipe out all the capital invested by the manager. This rarely happens with publicly listed companies.

· Private equity investments have traditionally been subject to much higher fees than public investments. However, new avenues that are opening for investors interested in private equity, like those offered by iSTOX, bring these costs down considerably.

· Traditionally private equity investments have been illiquid, with investors locked in for anywhere from four to 10 years and unable to sell their investments to anyone else. However, this is changing. Investors on iSTOX, for example, have access to the iSTOX Exchange, our in-house trading platform.

When investing in alternative investments like private equity, investors need to do a lot more homework than when they invest in publicly listed equities. However, the nature of private equity investing is already changing. It is likely to become more readily available to a wider pool of investors, with fewer of the drawbacks that currently exist.

As mentioned, private equity has historically outperformed public markets. According to research by Cambridge Associates and selected benchmarks, from March 2010 to March 2020, private equity returned 13.2% per year compared to 6.6% in public equities and 4.2% in fixed income securities.

Another factor contributing to an investor shift to private equity is the declining number of companies that want to go or, in some cases, stay on public markets. In Singapore, for instance, there have been more delistings than listings in seven of the last nine years, according to a CNA article published in March 2020. As a result, the number of listings declined to 723 in 2019 from 783 in 2010.

These factors have prompted investors to seek opportunities in alternative asset classes like private equity. As the access to individual investors becomes easier, the appetite for investing in private equity is likely to increase substantially.

What types of private equity investments are there?

In general, investors can access private equity in two ways: directly, by investing directly into a specific private company or by investing in multiple companies via various kinds of private funds. In either case, there are several different sub-types of private equity to be aware of:

Growth Capital

Private equity managers invest in private companies that they believe have excellent growth prospects. They usually take minority stakes in these companies.

Unicorn Investing

Let you invest in fast-growing privately-held startups valued at over US $1 billion. Many of today’s hottest and most dominant companies – Amazon, Airbnb and Google, to name just three – are former unicorns.

Venture Capital

Let you invest in early stage startups that have strong growth potential. Some consider this a private equity investment while others see it as an asset class of its own. Venture capital has a higher risk-reward ratio than the other types of private equity investments because the companies haven’t yet built up a performance track record.

Distressed

The private equity manager buys a company that is not doing well with an eye towards getting the company on the road to recovery.

Leveraged Buyouts

The private equity manager primarily funds a company's purchase with debt issued by banks. The loans are backed by the company assets, which means if the company cannot afford to pay back the loans, the investors are not liable.

Case Study: CVC makes a handsome profit from Kount sale

A private equity investment is only successful if the manager can sell the company at a profit at the end of the day.

In January, CVC Capital Partners sold market-leading AI-driven fraud detection platform Kount in a deal that meets all the requirements of a successful investment:

· At USD640m, CVC secured a return of almost 5x the fund’s initial investment in the company

· The investment's gross internal rate of return was 34% - an exceptionally high return by anyone’s measure.

Singapore-based iSTOX is the world’s first integrated platform for digital securities. Regulated by the Monetary Authority of Singapore (MAS), iSTOX uses proprietary technology to directly connect buyers and sellers. In so doing, iSTOX provides accredited investors with access to previously out-of-reach investment opportunities, including private equity, hedge funds, private debt and more.

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iSTOX

Opening Private Capital Markets To 21st Century Investors

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