The Allure, and Burden, of Private Equity

The first step to making a private investment is understanding the pitch. After all, there are some 7,000 private investment managers across the globe.

Determining the skill of the manager is important, so do your homework. Andrea Auerbach, global head of private investments at Cambridge Associates, a consultant and an adviser, said picking an average manager could affect your bottom line.

The difference in returns between public equity managers who are in the middle of the pack and top performers was less than three percentage points, she said. But when it came to private equity, the difference in returns between mediocre and top managers was 21 points.

A second step is spreading money across funds raised in different years, not just with different strategies. For instance, funds raised in the years before the recession made most of their investments when the market was at a peak, so they consequently performed worse than those that raised money in the years right after the downturn, when asset values were lower.

A bigger problem for investors in 2008, though, was that private equity firms demanded money from investors in a capital call. The timing was bad because some investors had put their money in the stock market and had to sell their shares at steep discounts to avoid defaulting.

“Most investors oversimplified it, which increased their risk,” said Adam I. Taback, deputy chief investment officer for Wells Fargo Private Bank. “You have to figure in the growth of every other asset. What’s happened to the other 90 percent of your portfolio while you’re doing all this private equity planning?”

Patience is a necessity in private investments.

The marketing material for these funds suggest the investment will last about seven years, but in reality, with clauses in the documents about mandatory extensions, some of these funds can drag on for twice as long.

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